Managing your wealth involves a plethora of decisions, from choosing how much money to save to selecting an appropriate asset allocation to picking individual investments. Every one of these decisions requires your brain to gather and process large amounts of information, which means that there are plenty of ways for it to make mistakes. One of the most common mistakes is “confirmation bias,” the (very natural) tendency for people to seek out and interpret information in ways that support beliefs they already hold.
Confirmation bias can occur in all aspects of life. In politics, for example, people tend to get information from the same news sources as other people who have similar ideological views. And they’re more likely to sympathetically interpret statements by politicians from a party they support, and to critically interpret statements by politicians from a party they oppose.
When it comes to investing, confirmation bias can affect almost every decision you make. If you’ve just increased your allocation to stocks, for example, you may (even subconsciously) be more likely to read news articles where the headlines suggest optimism about the economy. Or you may tune out anyone who suggests the stock market is going to do poorly. Over time confirmation bias can hurt your investment performance by making it more difficult to realize when you’ve made a mistake and potentially leading to additional bad decisions.
So how can you avoid these problems? The simplest way is simply to be aware of them. Realizing that it’s natural to seek out information that supports your existing views and actively pushing back against this tendency can go a long way. You can also come up with ways to objectively measure whether your decisions are panning out. Specifying your financial goals, monitoring your progress toward those goals, tracking your investment performance, and comparing yourself to appropriate benchmarks can all help mitigate the effects of confirmation bias.