A big part of the reason that we hang on to strange ideas is a psychological phenomenon known as confirmation bias. Basically, when we hold a particular view, we tend to give more weight to evidence and arguments that support that view, and disregard evidence to the contrary.
This means that if you believe in UFOs, you will pay close attention to and feel gratified by stories told by unusual people about being abducted and experimented upon by aliens. By contrast, you will pay little attention to the suggestion that the idea of super-intelligent alien beings visiting earth and principally abducting oddballs from rural America is probably nonsense.
The more arguments you hear that support your world view, the stronger your confirmation bias will become. In addition to UFO spotters, this phenomenon can be observed in conspiracy theorists, alternative medicine practitioners and anyone who has ever visited a psychic. But we all fall victim to our own confirmation biases every day, most importantly when we make investment decisions.
So, carrying on from last week, investment tip number six is: be aware of confirmation bias. About a year ago, I invested in HSBC stock at HK$111. I was of the view that HSBC was better placed to weather the financial storm than its peers. I have no idea how I came to this opinion, but it created a confirmation bias that has affected my decisions about this investment ever since.
If you remember, as the stock began to tumble, there were competing views among the commentators. The analysts who made the most sense to me were those who said HSBC remained a stand-out in the banking world and deserved its higher valuation.
If I had paid slightly more attention to those that said HSBC could not avoid the drop in asset prices affecting the whole industry, and that they would be forced to raise new equity one way or another, then perhaps I would not still own that block of shares, now trading at around HK$65.
Confirmation bias kept me from giving sufficient weight to the evidence that the fundamentals of my investment were changing. Being aware that confirmation bias is a natural human tendency can help you to change tack faster when circumstances change.
