Confirmation Bias and cognitive dissonance

Confirmation Bias and cognitive dissonance

September 27, 2022

We all love being right. Being correct feels a whole lot better than being incorrect, even though often times failures help you learn the most. Oftentimes to ensure that what we believe to be true is in fact true, we seek out knowledge that confirms that we are in fact in the right. This happens most notably in the political spectrum. Almost all of the major media outlets in this country, and internationally, have some sort of bias towards one end of the spectrum. Some outlet’s biases are fairly minimal and some swing hard to one side or the other. From the consumer perspective, we involuntarily prefer media to be this way. We love hearing information that confirms how we feel about something, whether its true or not. This is called confirmation bias and it can negatively affect the way we communicate with others and even our own perception of reality. In the past I have touched on other behavioral finance topics like this in other blogs which will be linked below.

We gravitate towards information that is comfortable, information that validates what we already believe to be true. The problem is that when we are then provided with information that objectively invalidates our prior beliefs, we refuse to acknowledge it because it makes us uncomfortable. This cognitive dissonance is our brains inability to allow new information to replace antiquated information in our heads because it makes us uncomfortable for some sort of reason. What is the point then of me even bringing this up? The fact is that these biases do not simply show up in our political coverage consumption or in choice of sports television. Confirmation bias and cognitive dissonance can be a tremendous detriment to your financial planning.

Let’s take a very simple example of what this look’s like when it comes to investing. Let’s say you have invested heavily in ABC company stock, (this is a fictional company, not the multimedia conglomerate. Just for reference). Hopefully you are not too heavily invested in this position because it is prudent to be well-diversified, but that discussion in not to be had in this blog. ABC has done very well for you. You invested when it was but a fledgling company and ABC’s success, as well as the stock bounce back after March 2020, was leaving you feeling good about the future. Sadly, in 2022 ABC is now struggling. The financials of the company are in dire straits. ABC’s earnings report recently came back devastatingly lower than what was expected. From an objective perspective, things are not looking bright. As stock losses pile, ABC sends out a statement to shareholders reassuring them of the company’s commitment to a better future and its reasons for optimism. You, while falling into your bias, take this statement as gold and refuse to see the truth that is apparent. So, you hold on for the ride with ABC stock and end up riding it all the way to the bottom when they finally declare chapter 11 bankruptcy.

That example was pretty extreme, but there are more subtle ways that we condition ourselves to plan in only one certain way. It may be that your parents or grandparents told you that you needed to invest your money in bonds. You believed that premise and stay invested in bonds throughout the accumulation phase of your working years, missing out on larger growth opportunities even when you have the risk tolerance for it. It could also go the opposite way. You want to be heavily invested in equities because that’s how a relative obtained so much wealth. You stay unequally invested in equities as you get closer to retirement, not realizing the risk involved with having such a volatile portfolio so near the withdrawal phase. The markets then turn and have a year like we have had so far and you are left with a nest egg that is much smaller than before.

This is part of what we do as financial advisors. We try to be an objective source that gives information about financial topics with no hidden agenda. Though, we still have to fight this too. This year has been a tough one in the stock markets. The volatility has exposed some inefficiencies in our portfolios. From our perspective we have to be willing to change and willing to listen to the problems that have presented themselves. A financial advisor who refuses to change and only plays his game through one product or a set-in-stone portfolio is no advisor at all. So, we have to accept when different positions in our portfolio are overweight or when they don’t belong at all. New information continually reveals itself at it can be difficult to accept when it challenges the preconceived notions we have in our heads. We need to accept it though to ensure that we are in fact working in the best interest of our clients.

If you want to read more about behavioral finance, read the blogs below!

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.