Imagine you’re sitting in a bar after a long day at work, nursing a gin and tonic while watching the returns in a local election. Everybody else is shooting pool or enjoying good conversation. You’re the only one paying attention because you’re the biggest political nerd in the place.
Suddenly, your attentiveness is rewarded when it appears the underdog is winning. Your mouth drops open. Nobody thought this guy was going to win.
Except you. I knew it, you think.
That expose on those papers the opposing candidate wrote in college. You knew that would blow it for her. You even said so.
You text your wife and tell her to turn on the TV. I told you so, you type. Delusions of grandeur fill your mind. You see it now. You would buy a domain, pay for hosting and marketing and launch your own political blog. Fame and fortune was on its way, derived from a crystal ball you alone can see.
Your wife calls.
She calmly explains that you did not tell her so. In no way did you ever really say you believed your candidate would win. She tells you to stop drinking and come home.
You stare at your drink for a while. Okay, maybe you’re not the political genius you thought you were.
Maybe I should try the stock market …
Hindsight Bias is for Real
The above illustration is an example of what we refer to as hindsight bias in the financial industry. As Nobel laureate Daniel Kahneman discussed in his book Thinking, Fast and Slow, human beings have a tendency to give themselves more credit than they ought to when evaluating results.
Despite evidence to the contrary, it’s easy to think we are political geniuses when we are “proven right” after an election when, in reality, we were never really as sure about the outcome as we believe we were. This mistaken belief in our own abilities gives us a skewed idea of how we ought to be investing our time and money.
Just because we happen to be right every now and again doesn’t mean it was because of a proven decision-making framework.
Investors do the same thing when they choose a winning stock. They look back and give themselves far more credit for choosing that stock then they should, after which they believe they are an expert, and try to make a “career” out of stock picking. The result can be disastrous.
How to Overcome Hindsight Bias
There is always a degree of luck in investing. You can’t reduce risk simply by believing you are above it; you can only reduce risk by making a plan, building a diverse portfolio, then sticking to that plan no matter how confident you feel about past performance.
Most importantly, don’t go it alone. We are all susceptible to bias. A qualified professional will not only help you build a sound plan based on objective reality, but will hold you accountable to that plan as you go along.
You need more than a friend on this journey. You need a financial lifeguard … someone to gently remind you you’re a mere mortal like the rest of us.
In other words, you should just put down the drink and come home.
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