“People generally see what they look for, and hear what they listen for.” -
Harper Lee, To Kill a Mockingbird
The original version of this article first appeared in The Business Times.
Once heralded as a game-changer in transportation and what “will be to the car what the car was to the horse and buggy,” the Segway was eventually relegated to glorified scooters for fanny-pack wearing tourists and mall security guards. The Segway was supposed to revolutionise postal services, police patrols and solve air pollution. The creator Dean Kamen once said he wished for US Special Forces troops to one day ride the machines into battle. Even Jeff Bezos was convinced, and he called it “one of the most famous and anticipated product introductions of all time” before the Segway first went on sale on Amazon.com. But this once viral sensation and technological marvel went down in flames shortly after launch, and finally petered out in 2020 when production was discontinued. How could it have gone so wrong?
This was an example of confirmation bias – Kamen and his backers only sought affirmation from those who believed in their vision, and assumed people would love their product. The Segway was codenamed Ginger after Fred Astaire’s dance partner Ginger Rogers, and the product development was shrouded in secrecy. The marketing team struggled to conduct market research because they couldn’t tell anyone what the product was. Kamen and the titans of Silicon Valley were blinded by the fact that no one inherently needed a Segway. It was a novelty, but there was no compelling need for anyone to buy this expensive contraption. Without market research or user feedback, the creators were then shocked when the product was criticized for being heavy, uncool and awkward to maneuver.
We’re hard-wired to suffer from confirmation bias – the tendency to put more faith in information that confirms our pre-existing beliefs while discounting opinions and data that are contrary to our beliefs. So rather than “I’ll believe it when I see it”, we tend to actively seek evidence that supports what we already believe in, and take the approach of “I’ll see it when I believe it.” Even when reading the news, we tend to disregard information that is not in line with our beliefs due to confirmation bias. Social media has caught on this bandwagon too, where Facebook’s algorithms will generate news items it knows you want to see and are in agreement with your worldview.
For investors, confirmation bias is particularly dangerous. Let’s say you buy shares in Droom, a robotic dog-grooming company. You think it’s the best idea since sliced bread. You only notice the reports that say dog ownership rates are rising and that more of them are looking unkempt, and ignore negative news on the company’s lack of sales and high hardware costs. We often stick with a declining stock far longer than we should because we interpret every bit of news in a way that favours the company and bolsters our investment thesis, and dismiss negative information as irrelevant. This also helps to explain why bulls tend to remain bullish and bears tend to remain bearish, regardless of what is actually happening in markets. The truth is – even experienced investment professionals suffer from confirmation bias. In the case of Segway, Kamen had received substantial funding from the famed venture capitalist John Doerr, the largest investment in the firm Kleiner Perkins’ history. This gave more reason for Segway’s backers to persist in their belief in the potential of the product. Unfortunately for our investment portfolios, we are biologically hardwired to process data that confirms what we already believe.
Psychologists term heuristics as the process by which we use mental shortcuts to solve problems and make judgments quickly and efficiently. Our brains are designed to process information quickly, which means that instead of assessing all the available information to reach an evidence-based conclusion, we tend to formulate a hypothesis and then find information that supports it. It’s how our minds can filter and make sense of the overload of information available to us.
We can be influenced by behavioral biases at different points of our investment journey, but they become especially pronounced during periods of volatility. Back when covid-19 started hitting hard, we witnessed how missing toilet paper from supermarket shelves sparked a confirmation bias effect and irrational stockpiling, and how the market sell-off similarly triggered confirmation bias for many investors and fueled additional liquidations that accelerated the decline. Investment professionals and the media helped reinforce the parallels with the Global Financial Crisis of 2008, with a spike in reports and prediction of ‘financial crisis’ and ‘deflation’ in early 2020. These concerns ultimately did not materialize, and we did not slip into a financial crisis.
Source: JP Morgan Private Bank: A Key Lesson of the COVID-19 Recession, Bloomberg Finance L.P., Federal Reserve Bank of Philadelphia. As of February 28, 2021.
But it’s not realistic to rely on sheer willpower to overcome our behavioural shortcomings. Using evidence-based strategies and investing in a disciplined manner can help us avoid succumbing to the pitfalls of our human fallacies.
Firstly, focus on goals-based investing, where you align your investment portfolios with your goals. When you invest with a defined purpose of achieving a certain goal, you can better identify how much you need to invest, the right investment strategy, and the appropriate level of risk to take to get you there. At the end of the day, our real ‘risk’ is not about underperforming a benchmark index, but it is the risk that we do not reach our intended financial goal, viewed alongside how far we are away from that goal, such as retiring with the lifestyle we desire. Periods of losses are emotionally tough for any investor to handle. But when we focus on long-term goals, it allows us to be less distracted by short-term market volatility.
Secondly, ignore the noise and create rules. It can be easy to feel overwhelmed by the relentless stream of news we are bombarded with daily. It can evoke strong emotional responses and anxiety from even the most experienced investors, and tempt us to make impulsive changes to our portfolios that deviate from our investment plan. Creating rules can help tune out some of the noise, such as automating rebalancing to ensure that your asset allocation is always aligned to your risk tolerance and goals, and setting up automated recurring investments (or dollar-cost averaging strategy) so that you’ll invest in a disciplined manner in the markets irrespective of market conditions.
Perhaps the largest mistakes that we make as investors are behavioural. Markets can be irrational in the short-term and we can be emotional, but over the long-term markets have rewarded discipline.
Source: Dimensional Fund Advisors, MSCI data in US Dollars. Growth of a dollar — MSCI World Index (net dividends)
Setting goals and creating a sound investment plan can help you stay invested when uncertainty inevitably roils global markets, and avoid making poor decisions influenced by our behavioural biases.
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