Imagine you turn up for work and you’re feeling a bit sensitive. For no particular reason you believe all your colleagues are performing better than you. You fear you may not be selected for the next important project.
Your boss then unexpectedly suggests you have lunch together. What goes through your mind at that point? If it’s “my boss wants to talk to me about my poor performance,” that’s confirmation bias.
In this scenario, you have ignored any positives and have looked for and focused only on the negatives. Your boss wants to see you, so it must be bad news... confirmation that you aren’t performing.
But it’s just as likely that he or she wanted to catch up with you or share some good news. Perhaps you have been selected to lead a big project.
Finding the facts to suit your theory
While filtering out the facts that you don’t like may not always have significant consequences, when it comes to investing it could be very bad news.
Suppose you are reviewing your long-term asset allocation; how much you hold in equities, how much in bonds and so on. You’ve been thinking for a while that markets are looking expensive so you’re minded to lock in some profits. You start doing your research and only read the stories that confirm your view. You write off the other articles as being written by inexperienced analysts or having invalid arguments. The result is you reduce your risk.
This may pan out to be the correct… but it could also turn out to be the wrong decision. However, the point is you haven’t based your decision on all the facts. You’ve been selective to get the result that you wanted. The one that will make you feel better in the short-run, but will not necessarily make you better off in the long-run.
So the next time you are thinking about your investments, check with yourself that you have done a full appraisal of all the facts. It doesn’t guarantee success, but it will give you a much better chance.
James Norton is a senior investment planner at investment firm Vanguard UK.