| Promiscuous Investing, Chapter 3 – Confirmation Bias
Promiscuous: "indiscriminate; casual; irregular; haphazard."
Seeking others who agree with us is human nature – birds of a feather flock together. A parallel notion is that of, "I'll believe it when I see it." While birds flock, humans tend to "see it when we believe it" instead of the other way around.
Formulating immediate decisions, like focusing on recent events (Ch. 2), is an important instinct. If we see a bear in the wild, we recognize the danger.
Of course, we could take out the smart phone and research bear attack probability - finding the chance of being killed by a bear is far less than by lightening. [1] In the moment, though, exiting is preferable.
Instinctual decisions have their place in emergencies, but are also pervasive in instances less urgent.
Thucydides put it well, "Using sovereign reason to thrust aside what we do not fancy is a habit of mankind." In psychology this is called – Confirmation Bias.
Simply defined – we decide what we believe, embrace whatever confirms that and dismiss everything else.
This bias is so strong people exhibit signs of inebriation after being told they were drinking alcohol, even though none was actually imbibed.[2]
So biased decisions can save us, but they can kill us too.
The most sophisticated continue to fall prey to Ponzi schemes. Our economy nearly collapsed on the absurd belief real estate values always go up. Why?
Everyone wants the easy payoff. The appearance others are cashing in lures us into taunting the bear - a decision that carries significant downside potential.
Dramatics aside, confirmation bias effects investing decisions more often than we'd like to admit. Exciting returns and 5 star funds are paraded in front of us every day. Because it did happen, once, somewhere; we want to believe it will happen, now, to us.
All we need do is act.
The Standard and Poor's Index vs. Active (SPIVA) study shows only 1 in 3 stock picking managers beat their benchmark (index) return over a 3 year period.[3] Annual DALBAR studies show 5 out of 100 perform this feat over 10 year periods.[4]
Still, the average investor changes allocation with changing beliefs, and generally underperforms the market around 60% over the same period.
I would remind investors of Sir Isaac Newton's 3rd Law of Motion: every action has an equal and opposite reaction. As brilliant as he was, Newton himself could not respect this law when investing. He lost the equivalent of $3,000,000 chasing returns in the South Sea Bubble in the 1720s.
Every trade has a winner and a loser; every opinion has a counterpart, and every cat can be caught - but not by chasing it.
The Wiser investor resists "confirmation" posed by performance or opinion. He remembers today tells us little about tomorrow. And he has the patience to wait for the cat to come to him.
I welcome your questions and comments.
becker@wiserfinancial.com
Marc Becker, AIF
Managing Partner, Wiser Financial Coaching
Columnist, The Advisor Sherpa
To read past articles and view past videos, visit: www.marcbecker.tv
[1] http://bucktrack.blogspot.com/2011/02/bears-should-you-be-afraid.html [2] Evidenced Based Technical Analysis, by David Aronson [3] http://www.standardandpoors.com/indices/spiva/en/us [4] http://www.wealthadviser.ca/index.php/newsletters/133-dalbar-2012-report
Trivia Time
This week's question: How many Michael Phelp's wingspans would it take to equal the height of the highest Olympic diving platform? Please round to the nearest whole number.
Do you know? E-mail your answer wendy@wiserfinancial.com and if you are correct, receive a free "Way to Go!", "You Rock!", or other congratulatory phrase. Then brag to all your friends about how smart you are.
The answers will be in next week's newsletter!
Last week's question: Which has the greater longitude number: The most populated station in Antarctica or the country where the first documented poisonous bird lives?
Answer: The first documented poisonous bird was the Pitohui which is found in New Guinea at a longitude of 147 degrees. The most populated station in Antarctica is McMurdo Station at a longitude of 166 degrees. Therefore, the answer is McMurdo Station in Antarctica.
Congratulations to David R. and Dick W. for getting the correct answer! What clever people.
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