Confirmation bias can lead to a poor investment strategy

SEEKING out information that reinforces our own thoughts and ideas while ignoring contradictory opinions is something we’re all guilty of.

It is known as confirmation bias and can affect our decision-making process across the board, including our approach to investing.

I frequently see clients who say, ‘I’m quite happy with my current investments, they seem to be going OK at the moment’.

But really all that’s happening is that everybody’s investments are doing OK at the moment because of the way the markets have been performing.

They use this as a reason to validate their original decision to invest in the way they’ve invested because it confirms their thought process and opinion.

I recently reviewed a client’s investments made by a major building society which have now been moved onto another platform where the client is paying 1.88% per annum for moderate performance and for getting the odd phone call to say ‘are you OK?’ and that’s about it.

Often it takes some hard facts to dispel confirmation bias.

I did the research and constructed a portfolio, which included the cost of face-to-face advice and annual reviews. All in it would cost the client 1.01% per annum.

By simply taking a pragmatic approach to their investments in this scenario the client could save £2,175 per year on a £250,000 investment compared to the building society.

I think this serves as a salutary lesson. Nobody likes to think they’ve made a poor or an ordinary decision or even one that can be improved on because outwardly they’ve got nothing to compare it against and hence confirmation bias comes into play.

Even in a falling market people pretty much take it on the chin and they say ‘well, everybody else’s investments are falling, mine’s falling and that’s that.’

But they’ve got nothing to relate it to because they’ve got nothing that compares ‘x’ with ‘x’ that says ‘is mine falling more and is it falling more because I’m paying higher charges?’ Or to put it another way, ‘Am I getting the same performance as everybody else but a worse result because my charges are higher?’

Equally, a person may ask

‘Am I doing better than anyone else? If they’re getting the same performance but their charges are lower then the answer is ‘yes’, their investment is doing better.

I think it’s an interesting psychological point that everybody thinks ‘I’m doing okay’ in the absence of wanting to recognise that they might not have made the best decision or they’re invested with someone who has no interest in telling them they could have made a better decision elsewhere.

Any Independent Financial Adviser (IFA) worth his or her salt is going to do that, even if the client doesn’t necessarily want to hear it.

They’re going to say ‘You can improve on this because you’ve got other options available to you’. Whereas if someone’s selling their own products and services they’re really not going to talk somebody into leaving them.

Sometimes they reinforce that confirmation bias by just feeding you information that supports the status quo because they have a vested interest in doing that.

You may not want to hear that you haven’t made the best financial decisions, but if you want your investments to achieve the best result, honesty is the best policy.

Remember, the value of your investments can go down as well as up. Past performance is not a reliable indicator of future outcomes.