Confirmation bias and financial decisions

What is the confirmation bias?

Confirmation bias refers to the cognitive tendency to actively search for, interpret, process and recall information that supports their existing view while disregarding or minimizing information that challenges their viewpoints.

Essentially, individuals have a tendency to favor information that aligns with their pre-existing beliefs, while being more skeptical of information that contradicts their opinion.

Confirmation bias can lead to distorted perceptions of reality, as individuals unconsciously filter out information that challenges their beliefs and only pay attention to information that supports what they already think. This bias can affect decision-making, problem-solving, and the formation of opinions.

This phenomenon can occur in various contexts, and is particularly evident when individuals perceive the issue at hand to be personally relevant or of high importance, this can involve their expectations and predictions about the outcome of a situation.

Examples of confirmation biases

  • Political Views: People who hold strong political beliefs might only consume news and information from sources that share their perspective, ignoring information that presents alternative viewpoints.
  • Health Beliefs: Someone who believes in the effectiveness of a certain health remedy might only seek out anecdotes or studies that support that belief, while disregarding evidence that suggests the remedy might not be as effective.
  • Investment Decisions: An investor who is convinced that a particular stock will perform well might focus on news articles or analyses that support this view while ignoring or downplaying negative information about the stock.*Interpersonal Conflicts: In an argument, individuals may primarily remember instances that support their point of view and forget counterarguments presented by the other party.

The Wason selection task

Various academic studies have been run on confirmation bias. One of the most famous is the Wason selection task (1960s).
The task involves four cards, each with a number on one side and a letter on the other, arranged in a particular way. Participants are given the following rule to test: “If a card has a vowel on one side, then it must have an even number on the other side.”
Participants are then presented with four cards: A, B, 4, and 7. Their task is to determine which card(s) must be turned over to test whether the rule is true or false.

The correct answer is that cards A and 7 must be turned over. This is because turning over card A is necessary to check if it has an even number on the other side (testing the “vowel – even number” part of the rule), and turning over card 7 is necessary to check if it has a vowel on the other side (testing the “even number – vowel” part of the rule).

However, the Wason selection task has shown that people often struggle to arrive at the correct answer. This experiment highlights several cognitive biases and reasoning challenges:

  • Confirmation Bias: Participants tend to focus on confirming the rule rather than falsifying it. They are more likely to turn over cards that have vowels on the other side, as this would confirm the rule for those cases.
  • Framing Effects: The way the problem is framed influences participants’ reasoning. When the problem is presented in terms of confirming a rule, participants are less likely to arrive at the correct answer compared to when it’s framed as finding cases that violate the rule.
  • Belief Bias: People’s preexisting beliefs can influence their reasoning. Even if participants understand the logical rule, their personal beliefs can still impact their decision-making.
  • Pragmatic Reasoning Schema: Some researchers propose that people rely on a pragmatic reasoning schema that involves social contracts and permissions. For example, participants might consider the cards in terms of “if you’re over 21, you can drink alcohol.”

The Wason selection task is a valuable tool for studying human reasoning processes and cognitive biases. It highlights the challenges people face when evaluating conditional statements and demonstrates how biases can impact logical thinking and decision-making.

The types of Confirmation Bias:

  • Biased search for information

This type of confirmation bias refers to people tendency to search for evidence in a one-sided way to support their existing hypotheses or theories.
Experimental studies have demonstrated this phenomenon, showing that individuals tend to construct tests that are more likely to produce a positive outcome for their favored hypothesis, while overlooking the possibility of obtaining similar results for other hypotheses.

  • Biased interpretation of information

It refers to the tendency of individuals to interpret evidence in a way that aligns with their existing beliefs, while evaluating conflicting evidence more critically. Various experiments have shown that people tend not to change their beliefs on complex issues even after being provided with research because of the way they interpret the evidence.

  • Biased memory recall of information

To reinforce their existing beliefs, people may remember/recall information selectively.

Effects of Confirmation Bias:

  • Reinforcement of Biases: Confirmation bias reinforces existing beliefs and attitudes, making it difficult for individuals to change their minds even when presented with contradictory evidence.
  • Limited Perspective: By ignoring opposing viewpoints, individuals limit their exposure to a diverse range of opinions and information, hindering their ability to make well-informed decisions.
  • Polarization: Confirmation bias can contribute to the polarization of society, as people become more entrenched in their own beliefs and less willing to engage with differing perspectives.
  • Impaired Problem-Solving: In problem-solving, confirmation bias can lead individuals to overlook potential solutions or approaches that don’t align with their preexisting ideas.

How to mitigate the confirmation bias?

  • Diversify Information Sources: Seek out a variety of sources that present different viewpoints to gain a more balanced understanding of an issue.
  • Challenge Assumptions: Regularly question your own assumptions and beliefs. Consider the possibility that you might be wrong or that there’s more to the story.
  • Engage with Differing Views: Engage in conversations and discussions with people who hold different opinions. This can help you understand their perspective and challenge your own biases.
  • Consider the Opposite: Actively seek out information that contradicts your beliefs and try to understand the reasoning behind those opposing views.
  • Practice Critical Thinking: Develop critical thinking skills that allow you to evaluate information objectively, regardless of whether it supports or contradicts your existing beliefs.

Recognizing and actively addressing confirmation bias can help individuals make more well-rounded, informed decisions and contribute to more open and constructive dialogue in various areas of life.