Cash alert: Watch out for confirmation bias
Confirmation bias is a concept from the field of cognitive psychology which has important links to personal finance. It relates to favouring information, data or stories which confirm our pre-existing beliefs. Not only do we seek out information which backs up what we already believe to be true - we consciously ignore, underplay and criticise contrary information.
This universal aspect of the human psyche reveals itself through selective recall of information and a bias in how this information is interpreted. The strength of confirmation bias is compounded when the information relates to emotional issues or subjects which touch upon deeply held beliefs.
Examples abound in many different fields of life. In politics, this means we seek out positive information about political leaders and political parties we already support - and also search for negative stories about our political adversaries. In the UK think pro and anti-Brexit.
In investment confirmation bias might display itself through identifying with a particular product, such as gold or crypto currencies and filtering out any negative stories focusing only on positive tales of spectacular returns. Similarly, someone might be convinced that equities are “risky” and focus on financial media stories about stock market declines.
Confirmation bias is also present in our more general behaviour and attitude around money. Individuals might, for example, be convinced that they "must spend to be happy” and therefore when purchases are made which lead to debt, they will to say to themselves "I had to spend this money to keep up with a lifestyle which makes me happy ". Evidence to the contrary, for example times they did not spend and were still happy, is ignored or underplayed. Money, with its tremendously important emotional undercurrents and the fact it reflects deeply entrenched beliefs shaped by family and society, compounds and magnifies the role of confirmation bias.
There are steps we can take to mitigate the negative force of cognitive bias on our attitude to money. The first is to be aware and acknowledge the impacts it has on how we think about and spend money. The second is to be open to opposing arguments and evidence. So, in the case of equity investments, look at data showing stock market returns over time and, in the case of spending equals happiness, look for role models who don’t spend much but are happy and content.
Challenging deeply held beliefs is not easy, as Warren Buffett has said "what the human being is best at doing is interpreting all new information so that their prior conclusions remain intact." But by being curious about opposing views it is possible to move beyond inherent bias and see the world from a different perspective. This awareness can lead to action, bringing energy and agency in shaping new positive money habits.
If you want to find out how financial coaching can help you address confirmation bias, please drop me an email at email@example.com