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Making Irrational Financial Decisions is Only Human (Part 3): Confirmation Bias

{3:50 minutes to read}

Parts 1 and 2 of this article series evaluate a few behavioral reasons that cause humans to make irrational financial decisions. Part 1 shows how anchoring can be detrimental to long-term objectives. Part 2 describes loss aversion and the concept of “pain of loss” vs “pleasure of gain.”

Another behavioral concept describes the human tendency to adopt biases in understanding and processing certain kinds of information and events. If “seeing is believing,” then why is it possible for two people to observe the same event or read the same article and reach different conclusions?

We all have preconceived opinions or biases. It is part of being human. A bias can be difficult to avoid because we tend to selectively filter information and pay more attention to things that support our opinion. We tend to ignore or rationalize information that doesn’t support our bias. Behavioral economists call this selective thinking Confirmation Bias.

It is easy to see how this kind of bias can affect our decision-making. We tend to read opinions from journalists and listen to pundits who support our opinions. In today’s technological world it is very easy to tune out and dismiss news that we disagree with. Our biases can become even more resolute as exposure to “supportive” information overwhelms data, details or opinions that do not support our bias.

In financial planning, people will often make decisions based on a bias and ignore data that suggests they should take a different approach:

An investor listens to a pundit on television discussing a great technology company with superior products and fantastic recent stock performance. The investor feels this is a great stock (he really likes their products) and wants to add it to his portfolio. The investor did not do any further research about the company or its prospects. The investor’s advisor has been following the stock and the technology sector and attempts to dissuade the client from this purchase for a number of rational and thoughtful reasons. The advisor believes it’s been an excellent recent performer, but the stock price has become too expensive relative to other technology stocks.

Nevertheless, the investor has made a decision and tells the investment manager to purchase the stock. This is an example of confirmation bias. The investor accepted the information that supported his bias and ignored the data and advice that did not support his opinion.

At the Raskin Planning Group, we focus on objective analysis. We use financial modeling to help our clients make decisions. We aren’t emotionally attached to a specific security or planning concept. Our clients are given options and data to help them make the best decisions based on their personal objectives. This is an ongoing process that is reviewed at least annually.

Please call us today if you have questions and would like objective, analytical comprehensive planning that is designed to help you and your family accomplish your goals.

Peter Raskin is a registered representative of Lincoln Financial Advisors Corp. Securities offered through Lincoln Financial Advisors Corp., a broker-dealer (SIPC). Investment advisory services offered through Sagemark Consulting, a division of Lincoln Financial Advisors Corp., a registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. 125 Summer Street, Suite 1400, Boston, MA 02110 617.728.7444 Rasking Planning Group is not an affiliate of Lincoln Financial Advisors. CRN-1376793-122115

Making Irrational Financial Decisions is Only Human (Part 1): Anchoring

Making Irrational Financial Decisions is Only Human (Part 2): Loss Aversion

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