#90: Confirmation bias

Hi friends,

This week, I was a guest on a Private Bank investments podcast talking about two key behavioural biases that investors should be aware of, especially now in the context of all that is going on in the world presently.

Behavioural biases are systematic deviations from rationality, predictable errors or influences that apply to all of us when we interpret information and make decisions. An awareness of them can help us to attempt to limit their impact as we go about our lives.

I discuss Confirmation bias - a tendency to seek out, and pay more attention to, news and views and stories which confirm our own pre-existing views and beliefs - and the Availability heuristic - a mental rule of thumb where information which is more readily available in our minds gets given greater weight.

These biases, as well as the insight in the podcast, apply beyond investing more broadly across our daily lives, so I share it as this week’s edition.

You can listen on Spotify, and Apple Music (I come in around 4 mins 30 for approx 15 mins), or if you prefer to read it, the transcript is below.

Podcast transcript

Julien Lafargue (JL): Welcome to a new edition of Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and I will be your host today.

As usual, we’ll first go through last week’s events, before welcoming a guest. And today, I’m very pleased to be joined, after a trip to Saudi Arabia meeting clients, by Alex Joshi, Head of Behavioural Finance here at Barclays Private Bank, to discuss investor sentiment and maybe some of the key takeaways from his trip in the Middle East, and what clients think about the world these days.

…

Now, let’s move on to our guest segment, and speak a bit to Alex to get his feeling, and clients’ feelings at this point in time. We’ve discussed a few things only today, but there’s a lot happening at the moment. We’re thinking, you know, of geopolitics, the US election, and closer to home, the UK Budget is coming up. I’m sure it must feel like a lot to digest for everybody, and our clients in particular.

I know a lot of investors are asking me, OK, so how do I position, in this context? And the overall feeling tends to be that it may be better, for now, to just wait and see, because there are so many potential catalysts on the horizon, so waiting for that clarity could be the best thing to do before making any decision.

So, Alex, let me start by asking you what you would say to those investors that like to wait and see, let’s say, for example, for the US election outcome?

Alex Joshi (AJ): Good morning, Julien. Thanks for having me. It’s good to be back. So, yeah, firstly, just a point around sentiment and my views, just based on conversations I’ve been having recently.

So, I’m finding, when speaking to investors, that sentiment is relatively bullish and investors, on the whole, are pretty optimistic, and I guess that does make sense when you look at the index levels. But I feel that, as you made reference to in the question, investors are keeping a close eye on a lot of events going on at the moment. It can, at times, be a little bit overwhelming to sort of make sense of everything on the horizon.

Now, on the question about waiting and seeing, so let’s say for the US election, I also experience this quite a lot. I think it’s very common to want to do that, because uncertainty is uncomfortable. And I guess the key message, I would say here to investors, is that one of the few things which is certain in investing is uncertainty, unfortunately. It always exists.

You know, last week on the podcast when you were speaking to Nikola and you were talking about options, volatility spiking in the run up to the election and just after it. And volatility, whilst uncomfortable to experience as an investor, doesn’t necessarily stop one from reaching your long-term goals. So, I think that’s one key thing for investors, in particular for long-term investors, to keep in mind, is that this uncertainty, and the volatility which is associated with it, that creates these bumps in the road is uncomfortable, but it’s important to keep that longer-term perspective. Because, for many investors that are waiting for certainty, they can find themselves, on the sidelines for a long time.

And if you’re holding cash for a long period of time, waiting for that perfect entry point, it’s important to keep in mind the costs of holding cash, in the sense of the opportunity cost of forgone investment returns, as well as the erosion from inflation. You know, this year, despite everything that is going on and everything that’s on the horizon, indexes have still been hitting all-time highs.

If we take the S&P 500, for example, and we think about performance since the last Fed hike in the summer of ‘23, cash has given an investor a return of roughly 7.8% in that period, whereas US equities would have returned 32.8%.

So, even in this period where there’s a case for potentially holding cash to wait for a bit of certainty, especially given the higher rates of return that you could get from it, you know, there’s still the opportunity cost of those investment returns.

One point I’d make about cash is it can seem like a passive choice, a choice to wait and see, and investors can view it as, OK, I’m just waiting. I’m pushing this decision further down the line. I’d reframe it slightly and say that, it’s also an active choice to be holding cash. And so, as an investor with goals that one’s trying to achieve, it’s important to take into account, the risk-return implications of holding cash and how that will affect your goals.

And finally, on the US election in particular, it’s something that, of course, both you and I have written about in the last few months, and I think it’s important just to remind investors when it comes to elections, in the US as well as in other countries, that it’s, in most cases, the state of the economy which matters most for subsequent equity-market performance, rather than any party or candidate that wins, because in most economies you’ve got checks and balances.

In the US, you know, a president’s ability to govern and to implement their platform is going to be largely dependent on the shape of Congress. And there’s also a very big difference actually between what is said on a campaign trail and what gets implemented. So, I think it’s important there to separate the politics and the political headlines from the economics and the investing.

JL: I think you made an interesting point that most of the investors you talk to were bullish, and I think that that’s a fair assessment. Equally, I don’t think we’re seeing people running out to invest and, as you rightly pointed out, there is a lot of discussion around, you know, cash is on the sidelines, should I invest, should I not invest, should I wait? I’m just going to say that there are currently $6.4 trillion sitting in money markets, meaning there is a ‘ton’ of cash on the sidelines, and I’m sure a lot of people are sharing that feeling of maybe I’m just going to wait.

And, if anything, this is a good thing for a current investor and for markets, meaning there is a lot of pent up demand behind markets at the moment, and those $6.4 trillion or so will need to find a new home, as interest rates come down.

Now, you often speak about all the biases that we as investors are subject to. We’ve got quite a few of those. Which one would you say is maybe the most relevant at this point? Which biases should we be most aware of?

AJ: There are two which are particularly important to be thinking about. And one of them just came to me as you were talking about the cash on the sidelines.

So, the first is the ‘availability heuristic’. And so heuristics are mental rules of thumb, things that we use to navigate the world to simplify decision making. And the availability heuristic simply says that things which are more readily available in our mind, take up more space.

So, when we’re thinking about investing, news headlines which are more dramatic or more emotive are the ones that we typically will pay more attention to. So, for example, this morning, on the way into the office when I was looking through the FT and I was scrolling through the headlines, the ones which are the more dramatic ones are the ones which, took my attention. The ones I clicked on, the ones I spent a little bit more time thinking about.

And the issue with that, the risk to an investor of doing so, is typically inaction, the sitting on the sidelines in cash that you make reference to, because those more dramatic and more emotive headlines in most cases are going to be negative. We also need to take into account that the news needs to be sold and ‘what sells’ is things which are a bit more emotive.

And the downside of paying more of attention to that, is that, as an investor, it becomes quite easy to then forget some of the long-term data and the trends which are relevant for one’s own investment journey. So, you focus very much on the very dramatic things, which in many cases are going to lead to a thought of, actually, let’s wait it out, let’s wait for some of this stuff to pass. And it can also affect both your composure and your satisfaction with being invested, if you’re, you know, focusing on all the negatives. So, that’s the first one, the availability heuristic.

The second one is ‘confirmation bias’, and this is something that gets spoken about at all times of year and all times in the investment cycle. But, I think it’s particularly relevant when we’ve got geopolitical issues and we’ve got elections.

So, the confirmation bias is a tendency that we all have to seek out, and pay more attention to, news and views which confirm our own pre-existing views and beliefs. And obviously, in times of elections, where you’ve got dramatic headlines and announcements etc, it’s quite easy to go down a hole where you seek out information that confirms views that you have.

Now the issue with that, when it comes to investing, is, you know, for one it can lead to some degree of over-confidence, in the sense of you believe that this is an outcome that’s going to occur and these are going to be the likely implications and, that in many cases can lead to investors attempting to sort of trade around particular events because they’ve got a strong belief that something’s going to happen and this is going to be the implication. So, you have that, which if you’re a trader is fine, but if you’re an investor that might not be completely aligned with what you’re seeking to do long term.

And it can also affect asset-allocation decisions, because if you’ve got a very strong view that something is going to happen then you’ll have a tendency to perhaps be a little bit less diversified, to kind of go all-in, to some degree, expecting a particular outcome, and both of these things together have this likely impact of potentially waiting on the sidelines and not participating altogether. Or, for those who are, potentially paying a little bit too much attention to some of the things that are happening in the short term, at the expense of the long-term investment journey.

JL: Yeah, and I think listeners should remember that once we get past the US election, let’s say, this is maybe the biggest question mark at the moment, there will be another issue that will also be raising the uncertainty level. As you mentioned, after all, media, newspapers, they have to sell, so they will find another issue that people should be worried about. Anyway, maybe practically, how do we, as investors, in your view, overcome those issues?

AJ: So, I think overcoming them, we can attempt to overcome them across a few different fronts. So, I think there are three which I’d focus on. So, the first is news, the second is the use of experts and the third comes to the portfolio.

So, from the news perspective, I think, very simply the importance of diverse viewpoints, looking for unbiased reporting which is more factual. So, focusing on facts over stories and narratives, and trying to distinguish between the emotion and the underlying story there, and thinking quite specifically about the implications of that, to try and move away from the narrative and actually thinking about, OK, these are the facts, how does this impact the market, how does this impact a portfolio? So, that’s on the first one around news.

The second is around experts. I think it’s important to be talking through views and decisions around wealth and investment portfolios at times like this, with someone that can give an impartial, professional sort of opinion on those decisions. And the reason for that is to try and sort of limit the emotion and the bias which potentially can feed into decision making, because it’s very difficult to de-bias ourselves as human beings, but what you can do is try and kind of work around them, take into account our own tendencies and speaking to someone about that can help.

And thirdly, around the portfolio. I think it’s very important, especially if we’re talking about elections, to distinguish between political headlines and the market, because not every political headline is going to have a significant impact on the market.

And then, it’s also important to distinguish between the market and one’s own individual portfolio, especially if an investor’s holding, you know, a well-diversified portfolio which follows a robust investment process, because many of the things which are currently taking up the headlines would not necessarily have, a very significant market impact, and then that market impact is not necessarily going to translate into the portfolio.

I think there’s a tendency to think about the impact of all these events at a market level, but, of course, an individual investor is holding their own individual portfolio, and so that’s the focus, that’s where investors should be thinking about and trying to take a bit of a step back from the high-level storylines and moves that are going on there.

JL: These were very important reminders, Alex. Thanks a lot. Anything else that you want to leave our listeners with? Any last comments?

AJ: Yeah, so I think I’d end just very briefly with I think four things that all investors should be sort of clear on and keep in the back of their mind when investing during these markets, and actually in any markets.

So, one, I think it’s important to be very specific on one’s own individual goals. So, what are you seeking to achieve, the time horizon associated with it, being very clear on what the goal for the investing is.

Secondly, having a plan on how you’re going to get there. So, thinking about wealth planning, thinking about investments, having a strategy that you’re going to follow. So, being as specific again about the plan to reach those goals.

Thirdly, to expect that at some point that plan is going to be disrupted, there’s going to be unexpected events, when, as you mention, as we pass some of these on the horizon there’ll be new things that come about. So, putting in place things from a both financial as well as a behavioural perspective to try and navigate some of these unexpected things.

So, from a financial perspective, that would be, you know, having a well-diversified portfolio, which is one of the few ways that you sort of can protect against the unexpected. From a behavioural perspective, it’s agreeing, ahead of time, about the actions that you’ll take or not take in response to certain events.

And fourth, and finally, the importance of thinking about risk in the context of one’s own investment journey. So, we talk very much about, you know, risk, geopolitical risk, and risk is typically associated with volatility. But it’s extremely important, when there’s a lot of discussion about risk, for all investors to remember that the key risk should be the risk of not achieving your own individual financial goals.

So, I think that’s the final comment I would make here is just remember to be as specific as possible and keep focused on your own portfolio, your own goals, your own journey, which can, I think, help to sort of navigate a bit of the turmoil that’s going on presently in markets.

— AJ

On my bedside table:

📰 Article: Teenage social media use strongly linked to anxiety and depression, Financial Times. I found the comments section just as interesting as the article.

💬 Quote: “Maybe you’re not just tired, but uninspired."

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