Here are a few examples of confirmation bias: What is confirmation bias?Ĭonfirmation bias is the tendency to interpret new evidence as confirmation of one’s existing belief.
I encourage you to break away from hindsight bias when looking back.
Is this decision being made with my long term or short term outlook in mind?Īs we say, hindsight is 20/20 - no, not the year 2020, although the year provided us with numerous events to say “I told you so”. What events in the past are giving me belief/disbelief in this decision?. What do I know now that I didn’t know then?. It’s important to ask yourself the following questions: Market timers have an increased probability of missing those 10 best days. According to a study done by JPMorgan, if you missed only the 10 best days of the S&P 500 between 20 your investment return would have decreased by 50% compared to staying invested the entire time. Market timing is an extremely dangerous activity for investors. Hindsight bias like many other biases can lead to a tendency of market timing. Hindsight bias can lead to overconfidence (Natalie described this in the first part of our series) in your ability as an investor to select stocks. If that is truly the case, then the market decline itself would have been prevented. Looking back, investors and talking pundits on television can say that the indicators were there to see the market decline coming. It’s been around since Tulip Mania and the Great Recession. Hindsight bias tends to show up after any market bubble. It’s way too easy to look at that moment in history and say, ‘What fools! I would have never fallen for that!’ Those thoughts lead to hindsight bias. That equated to $5 trillion in market capitalization. As we all know, the bubble popped, and by the end of 2002 the NASDAQ lost 78% of its value. We know this now, but at the time, everyone had a valid explanation for it. If you haven’t already, check out our Acronyms Seriously Suck Especially in Finance blog to understand NASDAQ and P/E Ratio.Ī P/E Ratio that high means the NASDAQ was extremely overvalued. I just dropped a few acronyms in the last sentence, and for that I apologize. According to the Wall Street Journal, at the peak of the dot-com bubble the NASDAQ had a P/E Ratio (price to earnings ratio) of over 100 compared to the broad stock market index of 20. Many of the “.com” companies were not profitable, and yet were able to capture investment from the average household investor to large venture capitalists. The dot-com bubble lasted from 2000 to 2002. Hindsight bias is the tendency people have to perceive that previous events were more predictable than they truly were.Īn example of hindsight bias can be found after the dot-com bubble of the early 2000s. Read our blog to better understand how you can identify hindsight bias and confirmation bias before they influence your financial decisions. Hindsight bias can influence our present day decisions, so we must recognize it before acting.Ĭonfirmation bias, well, I’ll just say this… CNN or Fox News? Looking at past indicators, most investors would assume that the events were predictable, however if that was truly the case then one can argue that the downturn should have been prevented. Hindsight bias is present when looking back at previous market bubbles - Tulip Mania (check), the dot-com bubble (check) and the Great Recession (check). #Example of hindsight bias series
This week's Money Bias Series highlights two biases that tend to show up quite a lot in personal finance: hindsight bias and confirmation bias.
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