How “information Bias” Can Derail Your Investments (and Ways to Avoid It)
For the average investor, the news headlines don’t look good right now. Stock markets are in turmoil and the threat of recession looms . And during such economic uncertainty, our natural instincts can lead us astray.
When making investment decisions, it is important to have an objective and balanced point of view. Information bias occurs when our thinking is distorted by the way we filter and interpret data. If left unchecked, information bias can lead to poor financial decisions and missed opportunities, so all investors should be vigilant. Here are tips on how you, as an investor, can make informed decisions when considering your personal investment strategy.
Information bias leads to bad investments
Our natural tendency is to seek information that confirms our pre-existing beliefs. This tendency is known as confirmation bias, and it can spell disaster for investors. As John Kiernan, managing editor of WalletHub , says, “Many investors choose to seek out and interpret only information that reinforces their pre-existing beliefs, resulting in them missing opportunities and failing to adapt to changing market conditions.”
For example, if you believe the technology sector is poised for growth, you’ll be more likely to read bullish analysis on tech stocks. This confirmation bias causes you to overemphasize evidence that supports your thesis and ignore contradictory evidence.
Similarly, Kiernan explains that recency bias can cause investors to prioritize more recent data when making decisions and ignore historical trends, especially if it makes them uncomfortable. This can lead to “impulsive and risky investments as a result of short-term market fluctuations.”
If left unchecked, information bias can cause investors to:
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Panic selling during recessions, locking in losses
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Chasing productivity through hot sectors
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Ignore fundamentals in favor of hype and speculation.
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Overreact to temporary setbacks or fleeting good news.
Kiernan gives an example of an information bias that most people suffer from, whether we know it or not: overreacting to news. “Negative news and rumors about companies can spread quickly through social media platforms and online forums, causing investors to rush to sell their shares without fully understanding the potential consequences,” says Kiernan. You may consider yourself unbiased, but even reading one post with a negative tone (and failing to check other news sources before accepting the information as true) can cause “big problems” for individual investors.
Understanding your own decision making
Information bias aside, there are many very human qualities that separate us from robots—good for humanity, but bad for making money. For example, “anchoring bias” occurs when investors rely too heavily on the first piece of information they encounter when making decisions. “It can also lead to confirmation bias, which involves considering only information that confirms pre-existing beliefs or opinions and ignoring information that contradicts them.”
Additionally, Kiernan says investors tend to experience “loss aversion, which is the tendency to feel the pain of losses more than the pleasure of gains.” This results in investors continuing to hold onto losing investments rather than cutting their losses and moving on.
All the obvious biases seep into your investments. “Some people may take a moral stance against investing in companies involved in tobacco, cannabis, oil and gas, etc.” Whatever the specific bias, even if it is morally justified, it is “unlikely to help the investor make money.”
So, we understand that your decision making as a human may not be perfect. Now what? Let’s look at how investors are making smarter, more informed choices.
Tips for avoiding information bias
Panic is the enemy of good decision making. For example, Kiernan says one of his colleagues is a shareholder in a chain of public restaurants who had health problems that made the news. “Instead of panicking and selling in the face of bad press, he ate there several times a week for several months to see for himself what impact the problem could have. Soon the restaurants were full again and the stock price more than recovered.”
Here are some tips to help avoid panic and information bias when investing:
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Diversify your sources. Don’t rely on just one news publication, analysis or data source when researching investment opportunities. Get perspectives from multiple credible sources to balance any potential biases.
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Check facts and challenge assumptions. Don’t take statements at face value. Dig deeper to test claims and test underlying assumptions.
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Avoid echo chambers. Don’t just look for information that confirms your existing views. Try to read sources that challenge your thinking.
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Be mindful of how you process information. All people have biases in how they interpret data. Think about your own biases and investing style.
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Look at opposing points of view. For every investment thesis there is often a counter-argument. Seek to understand different points of view.
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Use objective quantitative data. When evaluating a stock, look at objective metrics such as financial ratios, growth metrics, and market share.
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Set a study end date. Set a point at which you stop looking for new information and make a decision based on what you already know.
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Reassess regularly. Review your investment rationale periodically to see if your initial assumptions are correct.
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Hire a financial advisor. An experienced professional can help point out blind spots in your thinking and research process.
The bottom line is that investors need to come up with a well-thought-out plan of action when things are calm, “before emotions and day-to-day distractions can cloud their judgment,” Kiernan says. Don’t let biased thinking derail your investment success.