Confirmation Bias: Understanding How It Affects Financial Decisions

Confirmation bias is the tendency of people to pay close attention to information that confirms their belief and ignore information that contradicts it. This is a type of bias explored in behavioral finance.Behavioral FinanceBehavioral finance is the study of the influence of psychology on the behavior of investors or financial practitioners. It also includes the subsequent effects on the markets. It focuses on the fact that investors are not always rational Our biases tend to limit our ability to make purely rational investment decisions.

Confirmation Bias Example

Let’s look at an example of confirmation bias:

I have four cards for you (each has a number on one side and a letter on the other side). One of the cards shows an E, one shows a 4 on one face, one has a K on one face, and one has a 7.

I say that a card with a vowel on one side (such as “E”) must show an even number on the other side.

My question to you is: Which card(s) do you need to turn over to see if I am telling the truth? And what’s the minimum number of cards you need to turn over in order to see if I am telling the truth?

What did you choose? Most people will choose the E and the 4. Unfortunately, that’s not the correct answer. The correct answers are actually E and 7.

If you turn over the E, and you find that there is an odd number, you’ve proven that I was lying.

If you turn over the 7 and you find that there is a vowel, then again, I was lying.

By turning over the 4, if there is a vowel on the other side, you only prove that you don’t prove anything. All you do is confirm my statement.

So, why are we biased to choose the 4? We explore this confirmation bias in more detail in CFI’s Behavioral Finance Course.

Being Prone to Confirmation Bias

We are all prone to confirmation bias. We tend to look for confirming, rather than disconfirming, evidence. Most of us have a really bad habit of only paying attention to information that agrees with our existing beliefs. We also have a tendency to form our views first, and then spend the rest of the day looking for information that makes us look right. Our natural tendency is to listen to people who agree with us. Because it feels good, it feels all warm and fuzzy, to hear our opinions reflected back to us.

I’d like you to think about where you get your news from. If you watch television, what’s your preferred news source? Do you prefer Fox News? Do you prefer CNN? Where do you get your news from? In fact, many of us choose our news sources based on this confirmation bias.

We choose the news that reflects our views and opinions. However, it is disastrous for investment decision-making. Instead, we should be looking for disconfirming information and disconfirming evidence.

So, start looking for information that actually might disprove your ideas rather than confirm what you want to do. That is how you try to guard against this bias.

Additional Resources

Thank you for reading this CFI explanation of confirmation bias in finance. To learn more, check out CFI’s Behavioral Finance Course. Additional relevant resources include:

• Behavioral Finance GlossaryBehavioral Finance GlossaryThis behavioral finance glossary includes Anchoring bias, Confirmation bias, Framing bias, Herding bias, Hindsight bias, Illusion of control
• Anchoring BiasAnchoring BiasAnchoring bias occurs when people rely too much on pre-existing information or the first information they find when making decisions. Anchors are an important concept in behavioral finance.
• Framing BiasFraming BiasFraming bias occurs when people make a decision based on the way the information is presented, as opposed to just on the facts themselves. The same facts presented in two different ways can lead to different judgments or decisions from people.
• Narrative FallacyNarrative FallacyOne of the limits to our ability to evaluate information objectively is what’s called the narrative fallacy. We love stories and we let our preference for a good story cloud the facts and our ability to make rational decisions. This is an important concept in behavioral finance.