Doing investment research?
You're probably wasting your time
Are you the type of investor who diligently researches an investment or the markets before making your decisions?
If so, you might be making a lot of mistakes: innate biases make it very difficult for any investor—even professionals—to make good decisions based on detailed research.
Here are some of the problems:
· More information often just confirms a decision already made.
· We tend to look only for information that confirms our bias and interpret all information as supportive, even if it isn’t.
· We tend to obey and follow figures of authority, even without good reason.
Information overload
Many studies have shown that increased information merely leads to increased confidence in a decision, rather than to a better and more accurate decision.
In one study, racing bookmakers were given information on a race and asked for their predictions. They were then given additional information and again asked to compute the odds.
Each time this process was carried out, the bookmakers became more confident in their predictions as the information increased. However, their accuracy did not increase from their first predictions.
In another study published in the Journal of Economic Psychology stock analysts were asked to forecast fourth quarter earnings for several firms. They were presented with the data in three formats, with the second format adding redundant information and the third format adding non-redundant information.
The additional information—whether redundant or non-redundant—reduced, rather than increased, the accuracy of their forecasts.
Confirmatory bias
Once we get information we don’t handle it very well.
Many studies have shown that we not only seek out information that confirms our biases, but that we tend to see all information as consistent with our beliefs, even when it clearly is not.
Numerous studies illustrate this point. In one, two groups—one opposed to capital punishment and one in favor—were given randomly selected studies on whether capital punishment deters crime. They were then asked to rate the studies. Those who supported capital punishment rated highly those studies that found it effective, and rated poorly those studies that found it ineffective. A similar result was obtained from the other group.
We are obedient
Doing research that involves reading the opinions of top investors also can hurt. Many studies have shown that we are deeply obedient to authority, even when our own experience or beliefs are contradicted by an authority figure.
In one classic study, subjects were asked to give electric shocks to other subjects who screamed and begged for mercy. Even though those giving the shocks thought they were real, they continued merely on the authority of a “teacher” conducting the test.
The best way to counteract these biases is to put your investing on autopilot by using indexed and asset class portfolios that buy large swaths of the stock and bond markets.