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Today's episode, we are getting back to cognitive biases that affect investor. Behavior. So we interrupted our series last week to talk about, uh, key takeaways from the Big Beautiful Bill. But this week and next we are gonna finish our series on cognitive behavior. I. Or cognitive biases that affect investor behavior.
So today we're gonna talk about the hindsight bias causes and examples and some things we can do to try and work through [00:01:00] or avoid this hindsight bias. So what is the hindsight bias? So the formal definition, according to Investo, PDM, and I'll be referencing an article from their website that I'll include in the show notes.
Today, but the definition is hindsight. Bias is a psychological phenomenon where individuals believe they accurately predicted an event after it has occurred, often leading to overconfidence in their predictive abilities. I certainly have fallen victim to this even very recently. My wife and I. Attended the Durham Bulls game.
And on the way to the, the game, I had just read an article in the Wall Street Journal talking about this bidding war right now for PhDs to come and work for companies that are front runners and pioneers and the artificial intelligence space and Facebook meta was, was one of the companies being referenced in this article.
And I mentioned to my wife, so back in 2020, during [00:02:00] COVID. Meta stock price dropped rather substantially. And I talked about at the time how, you know, it would be a good idea to put, um, a good portion of our brokerage account into the stock. Uh, we, we didn't because we know the importance of, of maintaining a diversified position and knew how speculative that would be, but.
Looking back five years, you know, since 2020 meta stock price has just soared, has, has just soared. But that conversation with my wife on the way to the Durham Bulls game recently, it suggests that I was falling victim to the hindsight bias. So this article was very timely for my personal reflection, but also I think it, it, it would be a valuable contribution to our series here.
So what causes hindsight bias? So I'm quoting here. Hindsight bias occurs when new information comes to light about an experience changing how we recall that experience. We [00:03:00] selectively remember only the information that confirms what we know or believe to be true. Then, if we feel we already knew what would happen all along, we fail to carefully review the outcome or the reason for the outcome.
So again, using my, my meta stock example, the fact that it did rise, like I thought, but didn't know is just confirming my, my belief to be true. However, if it had not risen, which was equally possible at the time and I had acted on, on, you know, this decision, it would've, it would've certainly backfired. So.
Hindsight bias. Quoting again here is rooted in overconfidence and anchoring. After an event occurs, we use the knowledge of the outcome as an anchor to attach our prior judgements to the outcome. The issue may be partly science-based as well. Hindsight bias might not be tied to only the ineffective processing of information, but be rooted in adaptive learning.[00:04:00]
So anchoring, overconfidence, other cognitive biases that we've talked about as part of the series that come into play here. How do we avoid. Hindsight bias. So investors should be careful when evaluating their own ability to predict how current events will impact the future performance of securities.
Believing that one can predict future results can lead to overconfidence, and overconfidence can lead to choosing stocks or investments on a hunch not for financial performance or value. So how do we avoid it? The article suggests and I support brainstorming alternative outcomes. Think about other things that might have happened in the situation you're considering.
Keep a journal or diary, and this is really designed just to help you reflect on the way that you process information and give you kind of a record to, to reflect on how hindsight bias may be kind of percolating in your decision making process. And then over time, review these journal entries. So a [00:05:00] decision journal can help allow for better decision making in the future as well as prevent second guessing.
So I think those are ideas that can help combat hindsight bias. I think one of the, the other kind of more, um, strategic ways to go about it would be to keep intrinsic valuation in mind. So intrinsic valuation. Hindsight bias can distract investors from an objective analysis of a company. Sticking to intrinsic valuation methods helps them decide on data-driven factors, not personal ones.
Intrinsic intrinsic value refers to the perception of a stock's true value based on all aspects of the business. It may not coincide with an investment's current market value. So. That's why it can oftentimes be best practice to leave individual stock picking to the, the professionals, to the, to the investment analyst.
Not necessarily because they have a crystal ball, [00:06:00] but because they oftentimes are using data to drive their decision and not necessarily. Hindsight bias or some of these other cognitive biases that we, we all can be impacted by. So another example of hindsight bias that I hear a lot. Among my peer group now, now that sports betting is legal is, you know, you've got, I guess recently the NBA finals has passed, and so you had the Indiana Pacers, Oklahoma City Thunder, and just regular banter amongst the guys.
Talking about, oh, if I had just bet. OKC to win this game or or Indiana at home to win this game, I would've, I would've won. Again, they're falling victim to hindsight bias, looking back at how the outcome played out, but it could have been very different had they put money behind there, their decision. So [00:07:00] the bottom line here is hindsight bias is a natural human response to past events in which we believe we knew the event would happen.
We then associate. That belief with new events, even when circumstances that can affect the outcome are different. Keeping and wrote, revisiting journals, discussing the event with peers and analyzing the surrounding circumstances while imagining alternate outcomes or ways you can avoid making decisions when under the influence of hindsight bias.
And then again, always kind of referring back to intrinsic valuation or data. To help support your decision and not just, um, going off a, a gut feeling or even recency bias and having that, the name or, or the company in, in the news driving your decision. We'll round out this series next week on one final cognitive bias with a very.
Real example that affects a lot of my clientele right now as they are in their retirement [00:08:00] years. So stay tuned to Roundout this series and I'll look forward to being with you next week. Take care.