Beware of Confirmation Bias – And its Assault on Your 401k

There is a useful analogy that relates the observation a goldfish makes when looking through the rounded glass of his fish bowl and us – the human. As we might suspect, a goldfish observing the outside world through the lens of a glass bowl would see things differently than you or I.

To the goldfish, the mechanics of the world might appear in a constant state of  illusion as a result of the curvature of his glass house. The goldfish, though, having spent his entire life behind a glass screen, is likely unaware that his vision is obscured by glass simply because he is ignorant to anything else. A ball rolling on the floor in a curved line represents his reality even though the ball, in a humans reality, rolls in a straight line.

If this fish were of the scholarly type, he might catalogue and formulate a mathematical framework that describes his observations. As you might recall from your high school science class: this is what Sir Isaac Newton did when he observed that famous apple falling from the tree. The fish’s laws of motion, if written properly, would be accurate so long as every observation of outside objects were made through the lens of the fish bowl. However, if we applied these laws of motion written by the fish to observations made outside of the fishbowl, the math would break down as we observe balls rolling in straight lines, not curved lines.

Now, assuming you’re still with me, I’m going to make the connection between a goldfish looking through his fishbowl and us humans.

It’s important to remember, like the goldfish, that we humans observe and participate in this world through our own “fishbowl”. We rely on our senses and intuition to navigate this world. Sometimes, though, our intuition fails us and instead we participate in this world behind a screen of our own folly and consequently make irrational decisions. Thus, our senses and intuition act as our own glass lens and can sometimes obscure what would otherwise be rational choices.

I’m going to introduce you to a natural tendency that happens within us humans known as the “confirmation bias” or “confirmatory bias”. I will first explain what this tendency is followed by its potential impact on your retirement savings. Finally, I’ll give you a few tips on how to combat this tendency as you work towards meeting your retirement goals.

Confirmation Bias: A tendency for us to place a greater emphasis on information that agrees with our original beliefs while prematurely dismissing evidence that does not. In other words, we naturally ignore facts that don’t agree with our ideas and favor facts that do; we often do this without knowing it even takes place!

Suppose you entered a debate among your peers as to which restaurant provides the best service. For the sake of argument lets pretend a family member of yours owns restaurant “A”, while restaurant “B” is owned by an anonymous group. Lets say your friends all agree that restaurant “B” provides better service while supplying the appropriate evidence to support their claims. Now you, having a favorable bias towards restaurant “A” (because it’s owned by close family members), will provide evidence of “better” service from restaurant “A” to counter their argument. Now lets say a third party evaluated the evidence provided by you and your peers and came to the conclusion that the evidence in support of restaurant “B” was more definite and indisputable than the evidence in favor of restaurant “A”.

The confirmation bias says that you, having a prior opinion, will have a more difficult time accepting evidence that does not agree with your original belief even if the evidence is more conclusive and rational. This disregard for opposing facts happens under the radar of your conscious mind – the caveat being you are unaware this is happening.

The implications of the confirmation bias upon your retirement investing can be very dangerous. As you might suspect, when someone develops an original idea or belief, it can be difficult for them to change his or her mind about those original ideas even in the face of new and conclusive evidence. The confirmation bias if prevalent in many topics – even so in the world of personal finance.

Investment Example: Lets say you thought the appropriate mix of assets within your retirement account included a heavy emphasis on stocks. Perhaps you thought stocks were cheaply valued and as a result executed a strategy aimed at raising your equity exposure. Suppose, then, you were given a cogent analysis from a caring friend that suggests stocks might be too expensive and adding equity exposure to your portfolio is too risky. According to the confirmation bias, and to no fault of your own, you may (or may not) find yourself ignoring this evidence simply because it does not support your original belief.

What should we do as investors?

1. Increase Awareness – The best line of defense against undesired outcomes in life is often simple awareness. Educating yourself on topics like this can help safeguard against the problems they elicit.
2. Take opposing evidence more seriously. Try to look at new evidence as if you have no original opinion. This may be difficult but practicing it might help you discover the rational and best option.
3. Seek professional, fiduciary advice – The more opinions you hear, the more accurate your decisions. This, of course, includes opinions from those with opposing beliefs. Speak to an investment professional and ask for his or her opinion. And remember, if it disagrees with your opinion, try to falsify it with evidence of your own. Do not disregard it simply because it is not the answer you want to hear.

Want more on this topic? Click here to learn about a study conducted by Stanford University that gives evidence for this unusual occurrence.