How Confirmation Bias Could be Hurting your Investment Performance

Have you made up your mind on just about everything, even before you know what it is? For instance, when you meet someone, is your opinion of the person formed from the first impression? Or, when you hear a political argument from the other side, is your mind opened or closed? Are you able to concede the “good points” the other side make, or do you dismiss the whole argument? We encounter people and ideas every day, and, while most of us would like to think we are open-minded, human nature, being what it is, makes it extremely difficult to discard our preconceived opinions. So, we almost instinctively filter out the information that doesn’t support our preconceived notion or opinion, at least initially. Behavioral psychologists refer to this kind of selective thought process as “confirmation bias.”

What does this have to do with investing? Well, when you consider that our investment choices are usually guided by a thought process, it can mean everything. If that thought process is clouded by confirmation bias, you may be making important, sometimes life-changing, investment decisions with one-sided information, and that can dramatically skew the big picture you need to make fully informed decision. Some of the more costly mistakes investors make can be attributed to confirmation bias which often leads to poor decisions based on incomplete information.

Take, for example, the investor who hears his colleagues bragging about the latest hot stock they all bought which has already doubled in price. No one wants to be left out of the next big thing, but at least this investor has the sense to do some research on his own. As he pours through the reports and surfs the internet for validation of their claims, half of his mind is racing with thoughts of the new car he will buy, as well as the possibility that he will be thought of as a “chump” for not getting in on the deal. Granted, he is allowing greed and fear to creep into the process; however, in doing so, in begins to filter out any information that might raise red flags and, instead, focus on the information that validates the investment. Now, imagine that this investor made that investment at the height of the Dot Com Bubble.

Confirmation bias works subtly, some would say insidiously, inside the minds of investors as they seek nothing more than to make the best possible decisions with their money. Even those who spend as much time analyzing the cons as they do the pros of a given investment, confirmation bias tricks the mind into giving more weight or credence to the pros, if there is already a preconception in favor of it. Or, more overtly, it simply allows us to dismiss or discount information that doesn’t conform to our beliefs. That’s a very dangerous mindset when your money is at stake.

Overcoming Confirmation Bias

Overcoming confirmation bias is not as easy as you might think. It’s one thing to be aware of it and even make a point of dealing with it. However, it’s that same bias that often presents us from taking the necessary steps to avoid it. If you are the president of the United States, let’s say, and your policies seem to always go in the wrong direction as far as the public is concerned. You may convince yourself that you are right and the public is wrong if all you do is surround yourself with people who agree with you. Having the strength and security to include people who have differing viewpoints in your life can cure you of confirmation bias; if you are willing to examine their viewpoints with an open mind.

Overcoming confirmation bias doesn’t mean abandoning your beliefs or even your preconceived opinions; rather it means recognizing how your bias could lead to making bad decisions in any aspect of life.

Being aware of it and recognizing that it could, in fact, cloud your judgment is the first step. Then, in gathering and analyzing information, focus on that which doesn’t conform to your opinion or belief and try to understand why. This might involve inviting those who don’t share your opinion to give you their view without you arguing yours. Just listen and evaluate. The same can be done by reading blogs and articles by people with different views. The most important thing is to work through the thought process more rationally without fighting opposing viewpoints. 

1.  Standardized Performance Data and Disclosures

Russell data © Russell Investment Group 1995-2014, all rights reserved. Dow Jones data provided by Dow Jones Indexes. MSCI data copyright MSCI 2014, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The BofA Merrill Lynch Indices are used with permission; © 2013 Merrill Lynch, Pierce, Fenner & Smith Inc.; all rights reserved. Citigroup bond indices copyright 2014 by Citigroup. Barclays data provided by Barclays Bank PLC. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio.

Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities.  Diversification does not guarantee investment returns and does not eliminate the risk of loss.  

Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Sector-specific investments can also increase these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.

Lake Tahoe Wealth Management, LLC is an investment advisor registered in the States of Nevada, New York, North Carolina, South Carolina, and Texas.

Principal Risks:

The principal risks of investing may include  one or more of the following: market risk, small companies risk, risk of concentrating in the real estate industry, foreign securities risk and currencies risk, emerging markets risk, banking concentration risk, foreign government debt risk, interest rate risk, risk of investing for inflation protection, credit risk, risk of municipal securities, derivatives risk, securities lending risk, call risk, liquidity risk, income risk. Value investment risk. Investing strategy risk. To more fully understand the risks related to investment in the funds, investors should read each fund’s prospectus.

Investments in foreign issuers are subject to certain considerations that are not associated with investment in US public companies. Investment in the International Equity, Emerging Markets Equity and the Global Fixed Income Portfolios and Indices will be denominated in foreign currencies. Changes in the relative value of these foreign currencies and the US dollar, therefore, will affect the value of investments in the Portfolios. However, the Global Fixed Income Portfolios and Indices may utilize forward currency contracts to attempt to protect against uncertainty in the level of future currency rates (if applicable), to hedge against fluctuations in currency exchange rates or to transfer balances from one currency to another. Foreign Securities prices may decline or fluctuate because of (a) economic or political actions of foreign governments, and/or (b) less regulated or liquid securities markets.

The Real Estate Indices are each concentrated in the real estate industry. The exclusive focus by Real Estate Securities Portfolios on the real estate industry will cause the Real Estate Securities Portfolios to be exposed to the general risks of direct real estate ownership. The value of securities in the real estate industry can be affected by changes in real estate values and rental income, property taxes, and tax and regulatory requirements. Also, the value of securities in the real estate industry may decline with changes in interest rate. Investing in REITS and REIT-like entities involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. REITS and REIT-like entities are dependent upon management skill, may not be diversified, and are subject to heavy cash flow dependency and self-liquidations. REITS and REIT-like entities also are subject to the possibility of failing to qualify for tax free pass through of income. Also, many foreign REIT-like entities are deemed for tax purposes as passive foreign investment companies (PFICs), which could result in the receipt of taxable dividends to shareholders at an unfavorable tax rate. Also, because REITS and REIT-like entities typically are invested in a limited number of projects or in a particular market segment, these entities are more susceptible to adverse developments affecting a single project or market segment than more broadly diversified investments. The performance of Real Estate Securities Portfolios may be materially different from the broad equity market.

Fixed Income Portfolios:

The net asset value of a fund that invests in fixed income securities will fluctuate when interest rates rise. An investor can lose principal value investing in a fixed income fund during a rising interest rate environment. The Portfolio may also be affected by: call risk, which is the risk that during periods of falling interest rates, a bond issuer will call or repay a higher-yielding bond before its maturity date; credit risk, which is the risk that a bond issuer will fail to pay interest and principal in a timely manner.

Risk of Banking Concentration:

Focus on the banking industry would link the performance of the short term fixed income indices to changes in performance of the banking industry generally. For example, a change in the market’s perception of the riskiness of banks compared to non-banks would cause the Portfolio’s values to fluctuate.

The material is solely for informational purposes and shall not constitute an offer to sell or the solicitation to buy securities.  The opinions expressed herein represent the current, good faith views of Lake Tahoe Wealth Management, LLC (LTWM) as of the date indicated and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such.  The information presented in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, LTWM does not guarantee the accuracy, adequacy or completeness of such information. 

Predictions, opinions, and other information contained in this presentation are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Any forward-looking statements speak only as of the date they are made, and LTWM assumes no duty to and does not undertake to update forward-looking statements.  Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time.  Actual results could differ materially from those anticipated in forward looking statements. No investment strategy can guarantee performance results. All investments are subject to investment risk, including loss of principal invested.

Lake Tahoe Wealth Management Quarterly Commentary Q3, 2014

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