For the average investor, the headlines don’t look good right now. Stock markets are in turmoil, and the threat of a recession looms. And during this sort of economic volatility, our natural instincts can lead us astray.
When making investment decisions, it’s important to have an objective, balanced perspective. Information bias occurs when our thinking becomes skewed due to how we filter and interpret data. Left unchecked, information bias can lead to poor financial decisions and missed opportunities, so all investors should be vigilant about it. Here are tips on how you, as an investor, can make clear-headed decisions as you consider your personal investment strategies.
Information bias leads to poor investments
Our natural tendency is to seek out information that confirms our preexisting beliefs. This tendency is known as confirmation bias, and it can spell disaster for investors. As John Kiernan, managing editor at WalletHub, puts it, “many investors choose to seek out and interpret only information that reinforces their preexisting beliefs, causing them to miss opportunities and fail to adapt to changing market conditions.”
For example, if you think the tech sector is poised for growth, you’ll be more likely to read bullish analyses about tech stocks. This confirmation bias causes you to overweight data that supports your thesis and disregard contradicting evidence.
Similarly, Kiernan explains that recency bias can influence investors to prioritize more recent data when making a decision, and ignore historical trends—especially if it inconveniences them. This can lead to “impulsive and risky investments as a result of short-term market fluctuations.”
Left unchecked, information bias can cause investors to:
Panic-sell during downturns, locking in losses
Chase performance by piling into “hot” sectors
Ignore fundamentals in favor of hype and speculation
Overreact to temporary setbacks or fleeting good news
Kiernan gives an example of information bias that plagues most people, whether we know it or not: overreaction to news. “Negative news and rumors about companies can spread rapidly through social media platforms and online forums, leading investors to hastily sell their shares without fully understanding the potential impact,” Kiernan says. You may consider yourself unbiased, but even reading a single post with a negative tone (and not checking out other news sources before accepting the information as true) can cause “big problems” for individual investors.
Understanding your own decision-making
In addition to information bias, there’s a lot of very human behavior that separates us from the robots—good for humanity, bad for making money. For instance, “anchoring bias” happens when investors rely too heavily on the first piece of information they encounter when making decisions. “This can also lead to confirmation bias, which involves only looking at information that confirms preexisting beliefs or opinions, and ignoring information that contradicts them.”
In addition, Kiernan says investors tend to experience “loss aversion, which is the tendency to feel the pain of losses more intensely than the pleasure of gains.” This leads to investors holding onto unprofitable investments, rather than cutting their losses and moving on.
All the obvious biases seep into your investments, too. “Some people might take a moral stand against investing in companies that deal in tobacco, cannabis, oil and gas, etc.” Whatever the particular bias is, even if morally sound, it is “unlikely to be conducive to making money as an investor.”
So we understand that, as a human, your decision-making can’t be perfect. Now what? Let’s take a look at how investors make more rational and informed choices.
Tips to avoid information bias
Panic is the enemy of sound decision-making. For instance, Kiernan shares that one of his colleagues is a shareholder in a public restaurant chain that had a health problem hit the news. “Rather than panic and sell in the face of negative press, he ate there several times per week for months to see for himself what impact the issue might have. The restaurants soon filled up again, and the share price has more than bounced back.”
Here are some tips to avoid panic and avoid information bias when investing:
Diversify your sources. Don’t just rely on one news outlet, analyst, or data source when researching investment opportunities. Get perspectives from multiple credible sources to balance out any potential biases.
Check facts and question assumptions. Don’t take statements at face value. Dig deeper to verify claims and test underlying assumptions.
Avoid echo chambers. Don’t just seek out information that confirms your existing views. Make an effort to read sources that challenge your thinking.
Be aware of how you process information. All individuals have biases in how they interpret data. Reflect on your own inherent biases and investing style.
Look at opposing viewpoints. For every investment thesis, there is often a counter-argument. Seek to understand different perspectives.
Use unbiased quantitative data. Look at objective measurements like financial ratios, growth metrics, and market share when evaluating stocks.
Set a research cutoff date. Establish a point where you will stop seeking new info and make a decision based on what you already know.
Re-evaluate regularly. Review your investment rationale periodically to check if your original assumptions still hold true.
Hire a financial advisor. An experienced professional can help point out blind spots in your thinking and research process.
The bottom line is that investors should make a well-researched plan for action when things are calm, “before emotions and everyday distractions can cloud their judgment,” Kiernan says. Don’t let biased thinking derail your investing success.