Because of confirmation bias, Singaporeans may fail to challenge their beliefs, increasing the risk of making the wrong money decisions.
Knowing how to save money and spend wisely is well and good, but what really drives our money habits? Why do we spend as we do? In our new 'Money Mastery' series, we take a look at the psychological workings behind the scenes that govern your relationship with money.
Let's say you're in the market for a new gaming computer. Everspace, the shiny new rogue-like space shooter is about to be released soon, and you need a new rig to blow those ships up at maximum fps. You're making the final decisions on the specifications of your imminent murder machine; all you need now is to make some confirmations on a few more components. You pull up your favourite review sites, click through your carefully curated bookmarks, pull out a credit card that gives cash rebates for online shopping, and just a few clicks later, it's done.
A brand new Macbook Air is on its way to you.
What went wrong? Why did you, a well-informed, experienced gamer, pay good money for what could possibly be the worst choice for a new gaming computer? Turns out confirmation bias may have been to blame.
What is Confirmation Bias?
Confirmation bias is the tendency to seek out opinions and facts that support what one already believes about an issue. Any information to the contrary tends to be ignored.
The implication is this: We like to think our opinions are a result of years of rational and objective analysis. But actually, we pay attention only to information that fits with what we believe, while ignoring information that challenges our pre-conceived notions. Therefore, our “complete and unbiased opinion” cannot truly be so.
Want to see confirmation bias in action? Think about the last time you thought about making a purchase, say for a watch. Suddenly, you're noticing who's wearing a watch in a crowd, and who isn't. You may also start noticing your desired timepiece appearing in billboards and advertisement posters. Actually, the ads had been there for days or weeks; you just haven't noticed them until now.
Researchers have studied confirmation bias for over 50 years, and have found evidence of its influence throughout history. It was implicated for its role in drawing the US into the 16-year-long Vietnam War, and was also blamed for the Pearl Harbour disaster. US Admiral Husband E. Kimmel gave in to confirmation bias, failing to act when presented with early warning signs of the impending Japanese attack.
Facebook Only Makes It Worse
More recently, a five year study involving Facebook users demonstrated confirmation bias was the reason why misinformation spreads so readily, and why falsehoods persist on the social web.
Confirmation bias makes us seek out information that supports our beliefs, and to ignore contrary data. On Facebook, this causes users to choose and share stories that align with their existing positions, and to neglect those stories that do not.
As you know, Facebook shows you news stories that are popular (i.e., those that are shared, liked and commented on by your friends). Facebook is also increasingly becoming the main source of news for many. Combine the two and you'll begin to see how your opinions on trending topics may actually have been influenced a lot more than you'd like.
By Filtering Conflicting Information, Confirmation Bias Costs You More
Confirmation bias keeps us ensconced in our own little bubble of supporting evidence to continuously convince us that we are pursuing the right choice. However, because confirmation bias filters out conflicting information, it can lead us to make poor choices in important areas, such as personal finance.
Consider the plight of Long Term Capital Management, an investment firm founded in 1994 that realised returns of 21% in its first year, followed by 43% and 41% in the next two years.
Founded by John Meriwether, who recruited Nobel winners in Economics Myron Scholes and Robert Merton as partners, the firm attributed its success to a complex mathematical investing model that ensured the firm's spectacular gains.
However, in 1998, a default by Russia on its government bonds single-handedly caused the demise of Long Term Capital Management. Critics had warned that the firm's model would only work in a rational market. Confirmation bias had kept the firm from adjusting for unexpected events (perhaps by denying the possibility of the Russian default) resulting in a net loss of US$4.6 billion.
Deal With Confirmation Bias By Actively Challenging Your Beliefs
Firstly, we need to recognise that every one of us – that includes you, dear reader – is under the sway of confirmation bias. In fact, it is one of the most widely known and studied cognitive biases among investors.
Having recognised that our opinions are not as rational or unbiased as we think they are, we next need to actively challenge our beliefs.
Warren Buffet once invited his critic Doug Kass to the 2013 Berkshire Hathaway AGM, knowing that Kass would relish the opportunity to present more than a few scathing criticisms. Kass eventually failed to dissuade Buffet, but that wasn't the point. By actively seeking out contentious viewpoints from an opposing peer, Buffet made sure he confronted his confirmation bias.
Confirmation bias can weaken us by causing us to make a bad decision, or worse, to continue down the wrong path. When researching what is believed to be a winning stock, an investor may pay attention only to positive signs, and ignore any negative indicators they may encounter along the way.
Our opening example about the Macbook Air might have been a tad exaggerated, but confirmation bias has caused more trouble for smarter people than you or me. So perhaps, it would be a good idea to fight the urge to reflexively shy away from challenging beliefs or views.
By cultivating the habit of doubting ourselves – or at least, what we know – we might just save ourselves a penny or two.
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By Alevin Chan
A Certified Financial Planner with a curiosity about what makes people tick, Alevin's mission is to help readers understand the psychology of money. He's also on an ongoing quest to optimize happiness and enjoyment in his life.