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Making Irrational Financial Decisions is Only Human (Part 4): Hindsight Bias

{3:50 minutes to read}

Parts 1-3 of this article series evaluate 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." Part 3 discusses selective thinking, known as Confirmation Bias.

Have you ever heard a pundit on television mention, after the fact, a certain event was predictable and completely obvious because of reasons A, B and C? It seems like every day so called “experts” are telling us why certain events happened; they then suggest that someone should have known or predicted the result. This happens in sports, politics, natural disasters and financial markets.

Most events are totally unpredictable and are not obvious.

Hindsight Bias can be attributed to our human need to find order in a world that is unpredictable and sometimes chaotic. This need for order is sometimes helpful, like in the academic world of science or accounting, but finding links that don’t actually exist can result in oversimplifications and incorrect conclusions.

For example: An investor has owned stock in a large global oil company for many decades. It pays a nice dividend and has done very well over the years. It did especially well after the technology bubble of the early 2000’s and the recent financial recession of 2007-2009. This investor’s hindsight bias led to the conclusion that the stock will always be a great performer and should never be sold. Unfortunately, the stock price has been very volatile over the last 2 years and because of this recent volatility, the stock has significantly underperformed on the S&P 500 Index over the last 2, 5 and 10 years. This investor’s hindsight bias led to the wrong conclusion and thus the stock was retained. This investor would have been better off diversifying the portfolio.

Avoiding Confirmation and Hindsight Bias

It is very difficult to put aside our human tendency to selectively accept information and make decisions based on our opinions or biases. Unfortunately, in the financial world, preconceived notions about how things work often cloud our decision making and lead to less-than-ideal results. Overcoming confirmation and hindsight bias is difficult because we often don’t recognize when our biases are affecting our decisions.

At the Raskin Planning Group, we believe the role of a financial and wealth advisor is vital in the process of overcoming personal biases. It is our duty to act as a sounding board so that our clients have a “dissenting voice of reason,” if appropriate. Our clients are ultimately in control and make all of the final decisions.

Please call the Raskin Planning Group if you have questions and would like objective, analytical comprehensive planning that will help you and your family accomplish your goals.

Peter Raskin is a registered representative of Lincoln Financial Advisors. Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Raskin Planning Group is not an affiliate of Lincoln Financial Advisors. CRN-1383708-010516

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

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

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

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