How to Become a Better Investor by Counteracting Bias

June 30, 2017
Shirley M. Mueller, M.D.

When it comes to investing, the knew-it-all-along effect can get in the way of acquiring actual knowledge. Also known as retrospective bias, this psychological phenomena leads people to overstate after the fact what they anticipated prior to their decision. This can happen when making investments, especially for novices who have not learned to monitor their decisions. Continue below to learn how to combat your biases and become a more successful investor.

Making a paper trail for your investments is imperative to the success of your purchases

In the movie “A Beautiful Mind,” the schizophrenic John Nash’s mind leads him to think, perceive and believe that certain events will happen. These confabulations ultimately have a negative impact on his professional reputation and personal life. There is a name for this occurrance: hindsight bias.

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Hindsight bias leads us to see an event as having been predictable even if there was no objective reason to support this feeling. The first step in the fight against hindsight bias is not only recognizing it when it occurs, but understanding that human beings are always susceptible to it. After that, the only thing left to do is act.

Record keeping is essential, so always have a notebook handy to write down buys and expectations for the stock, exchange traded fund, mutual fund or bond that is purchased. It should also include reasons for purchase. Then, when it is sold, creeping determinism is outweighed by the fact that the reality is recorded.

Did it meet expectation or not? If the answer is no, why and how could the shortcoming be prevented in the future? When there is a disconnect between the anticipated outcome and the reality, knowledge is gained through record keeping. This results in an updating of accurate information, which is less likely if memory alone is relied upon for recall.

STRIVING FOR SUCCESS

An interesting corollary to hindsight bias is the role that experience versus deliberate practice plays in overcoming the bias. It is deliberate practice that is more important than trading experience. What works is accurate recording of successes and failures in order to learn from them.

This is because a fallible memory gets in the way of accuracy. There can be errors in initial impressions or in memory storage. As such, it is necessary to be cautious when believing our own undocumented recollections are correct.

These memories, by themselves, tend to be inaccurate, in part, because of our own need to demonstrate our self-worth to ourselves.

So, the next time you want to say “I knew it,” remember that this mentality can be your downfall when it comes to investing. Always do your due diligence in keeping track of your financial decisions.

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