Becoming a Better Investor: Hindsight Bias

Learning while investing isn’t easy! One reason is because hindsight bias can get in the way. It is the tendency of people to overstate after the fact what they anticipated prior to their decision. They do it to make themselves feel good, even though it is not accurate.

An example is the character that Bill Nighy plays in a recent film, “Their Finest.” It is about movies made in England in the early 1940s to engender female interest in WWII. In it, Nighy recalls his enacted scenes in extremely flattering terms. It is a, “if I do say so myself,” moment.

This same tendency happens when we make investing decisions, especially to naïve investors who haven’t learned to document their reasons for making investment choices. Happily, highly trained professionals do better.

FROM NAÏVE TO PROFESSIONAL: COUNTERING HINDSIGHT BIAS

Recognizing that not only is there a bias, but also that humans are vulnerable to it goes a long way. After that acceptance, action is the key. One way is to keep a notebook with date, buy and expectations for the stock, exchange traded fund, mutual fund or bond that is purchased. It should also include reasons for purchase. Then, when it is sold, instead of thinking we knew what was going to happen all along, the reality is recorded. Did it meet expectation or not? If the answer is “no,” why and how could a like decision be avoided in the future.

In other words, when there is a disconnect between the anticipated outcome and the reality, knowledge is gained through record keeping. This results in an updating of accurate information which is less likely if memory alone is relied upon for recall.

THE KEY TO SUCCESS

An interesting corollary to hindsight bias is the role that experience versus deliberate practice plays in overcoming the bias. It is deliberate practice that is more important than trading for years. What works is accurate recording of successes and failures in order to learn from them.

This is because a fallible memory gets in the way of accuracy. There can be errors in initial impressions or in memory storage. Thereby, it is necessary to be cautious when believing our own undocumented recollections are correct. These memories, by themselves, tend to be inaccurate, in part, because of our own need to demonstrate our self-worth to ourselves.

So, though most of us would like to be a famous movie actor like Bill Nighy, hindsight bias is one trait of his movie character in “Their Finest” that we best not emulate, at least if we want to be better investors.