We know from behavioural finance
that most investors, no matter how sophisticated, can succumb to confirmation bias, among other prejudices
. In other words, clients have a way of being their own worst enemies. However, they can avoid sabotaging their own investment plans by turning a critical eye on themselves.
Ted Jenkin, co-CEO and founder of US-based firm OXYGen Financial, has recommended four practices in order to avoid succumbing to confirmation bias. First, investors have to examine all evidence with equal rigor; that is, they should critically look at empirical information that supports their preferred choices, as well as data that supports other decisions.
“For instance, consider whether the U.S. market is a better bet than international right now,” Jenkin said in a recent piece for the Wall Street Journal.
“Or, how the GOP tax plan will impact the markets. Make sure you ask yourself the tough questions.”
Next, he said, it’s important to find someone who’ll play devil’s advocate. One might receive a hot tip from a person they like or trust, and they could be swayed into following the advice based on who gave it.
“Do yourself a favor and find someone you trust just as much to play devil’s advocate and argue the opposite,” Jenkin said. The person could build counter-arguments undermining the choice under consideration, or ones supporting other choices that could be better. Being able to turn to someone like that, he said, can help investors challenge their own thought processes.
Third, investors should be honest with themselves about their motives. “We often don’t realize the power of our own motives – and we aren’t honest with ourselves about what they are,” he said. When doing research on a specific stock that’s done well in their portfolio, investors should make sure they’re not just picking details to tell themselves that they made a good choice. Research should also include looking for information that suggests when the right time to sell is.
Finally, it’s important to avoid leading questions. “One of the biggest mistakes you can make as an investor is to ask questions that set you up to get the answer you want — not the answer you need,” Jenkin said.
He said investors should be mindful of the way they phrase questions: when asking for someone’s advice or take on a piece of investment news, don’t give any hints or signals that could bias the person’s response.
“And if you find that your financial adviser always agrees with your investment ideas, it may be time to find a different adviser,” Jenkin said. “Healthy and heated debates with my adviser have allowed me to make better personal and business decisions over the years.”
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