Tuesday, November 24, 2009

Confirmation Bias

Here is an article by Jason Zweig in the Wall Street Journal on the effects of 'confirmation bias' on investing behavior.

An excerpt:

"...your own mind acts like a compulsive yes-man who echoes whatever you want to believe. Psychologists call this mental gremlin the 'confirmation bias.' A recent analysis of psychological studies with nearly 8,000 participants concluded that people are twice as likely to seek information that confirms what they already believe as they are to consider evidence that would challenge those beliefs."

The article goes on to suggest ways to combat the tendency.

Learning to manage it is not an easy thing to do but well worth the trouble.

It starts with a disciplined investment process. An example of a useful rule to put in place is to spend at least as much if not more time reading -- and carefully considering -- opposing views on any investment. This can be a more difficult habit to develop than it sounds. Most of us prefer to read things that reinforce our own thinking.

"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman

In other words, not only do you need to learn to know when to go against the prevailing wisdom of others, it's just as important to know how to challenge your own prevailing wisdom.

This can prove useful -- if implemented the right way -- beyond the world of investing.

Check out the full article.


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