Over the past six months, I've watched a lot of retirees and would-be retirees lose far more money than they could afford to lose because they fell prey to confirmation bias. Investors in stocks like MannKind Corp. (NASDAQ:MNKD), Kinder Morgan (NYSE:KMI), or Seadrill (NYSE:SDRL) held on to these stocks long past the point where more objective investors might have bailed, in many cases doubling down and "loading up the truck" despite loud flashing warnings that they were throwing good money after bad.
In every case, these unfortunate investors were aided and abetted in this behavior by the presence of vocal online communities of other investors with significant holdings in the same stock. These communities were large enough that it was worth the while of journalists to write articles that would attract - and please - these investors. For example, almost any article written about battleground insulin-maker MannKind last year on Seeking Alpha, no matter how farfetched its argument or unqualified its author, could easily attract enough page views to pay the author $200 or more, because over 18,000 people were following the stock here on Seeking Alpha. KMI had almost 100,000 people following it here, giving authors who attracted followers from its ranks even greater payouts. So articles about these stocks appeared weekly and even at times daily.
But because the investors who follow any stock are largely those who already own them, there is an ugly phenomenon at work that guarantees that you will see far more articles supporting a long investment thesis than pointing out its flaws. That's because much of the response to anyone writing an article or comment that does not confirm that investment thesis are likely to be angry, dismissive, or insulting. Anyone who points out a problem with a widely held stock is likely to be accused of either being a "short" or of being in the pay of hedge funds or market manipulators. If the discussion takes place in an online community that permits it, posters who argue against the consensus belief about the stock are likely to be blocked or banned, so that investors need never hear a discouraging word.
It is very rare for opposing views to be examined in an objective manner in any online venue. Instead, attempts to present numbers or verifiable facts that undermine the consensus view are met with emotional tirades asking how anyone could want such a noble company to fail ("The product is green!" "The product changes lives!"), appeals to authority ("the founder is a billionaire! How dare you question his strategy?"), or personal attacks ("Who is paying you to post this drivel, shortie!").
Since it is no fun writing articles that result in torrents of abuse, it should come as no surprise that as companies deteriorate, the number of articles reassuring owners of controversial but heavily held investments starts to outweigh those pointing out the threats. Authors write for a variety of reasons, but most prefer not to write the kind of post that will fill up their inboxes with accusations and threats to life and limb. And for those who write for income, it's pretty clear that an author who can attract 5,000 followers by writing what those people want to hear will do much better than one who presents them with unpleasant truths.
But it the unpleasant truths that wreak havoc on your portfolio, and when you are a retiree who doesn't have 20 years ahead of you over which your portfolio can recover, the more unpleasant truths you contemplate, examine, and evaluate based on fact, the better off you will be.
Heeding only arguments that agree with decisions you have already made is example of the psychological behavior known as confirmation bias. Psychologists have found that people are hardwired to trust information that agrees with what they already believe and distrust that which doesn't. Because of this, people are most likely to admire the people who tell them what they already believe and to demonize those who present facts that challenge those beliefs.
This confirmation bias is useful when it helps you overlook evidence that your child is not, in fact, the best hitter on his little league team, or your husband the smartest guy in the room, but not when it makes you overlook the fact that a company you have invested in is being run by incompetents or shysters.
And don't kid yourself that though everyone else might be subject to confirmation bias, you aren't. This behavior is wired in. Unless you have a brain that processes emotion in a very unusual way, once you make a decision, it becomes your decision, and an attack on that decision is very likely to feel like an attack on you.
Arguments that suggest our decision was wrong are taken by our brains as attacks on our intelligence, our ability to make decisions, and hence our ability to survive. And once our brain identifies something as a threat, it is treated as one, and we respond emotionally, fight or flight hormones pumping, rather than rationally.
But, you might ask, why should you worry about confirmation bias if you aren't invested in one of these extreme battleground stocks? The answer is, because the same factors that become so blindingly obvious in these extreme cases are working far more subtly every day as you consider your investments.
You are likely to seek out reading matter, friends, or entire online communities where you know you will hear views that support the investing decisions you have already made. You are also likely to gravitate to communities that support broader-based investment approaches, rather than those built around individual stocks.
So, if you are a dividend growth investor, you may not feel threatened by another investor whose choice of dividend stocks is different from your own. You'll be tolerant of, though perhaps feel a bit superior to, the dividend investor who praises IBM (NYSE:IBM) when you believe Microsoft (NASDAQ:MSFT) is a far better choice, but your reaction will be less collegial when a writer suggests that a total return strategy is far better than a dividend-centered approach, no matter what facts they support to advance their case.
Similarly, the Boglehead who follows the strategy of buying low cost, widely diversified mutual funds to create portfolios that adhere to the principles of Modern Portfolio Theory will enter friendly debates with other Bogleheads about which mutual fund is the best choice for international diversification, but their willingness to entertain friendly, fact-based debate is likely to evaporate when someone tries to have a serious discussion about the benefits of investing in individually chosen dividend growth stocks.
How can you tell if you are being influenced by this kind of confirmation bias? A pleasurable or angry response to reading something may be the tip off. The stronger the emotional component to your response, the more likely it is that your confirmation bias has just kicked in. If your immediate reaction to reading a post is a warm rush that makes you want to immediately reply "Me too!", you are very likely to be showing confirmation bias.
Even more to the point, a voice inside you shouting, "Wrong!" or "Idiot!" half way through reading an article or comment that presents a well-reasoned argument supported by facts, is another tip-off, especially if you find it hard to even read the rest of the post once you realize it doesn't agree with your opinion.
When other people pile on and agree with you, confirmation bias will make you feel another burst of positive emotion and you will feel better. Their support will make you feel safe, just as disagreement makes you uncomfortable. If there are enough people involved in a discussion where someone has challenged the group's belief, you may enjoy watching others who agree with you gang up on the intruder and drive them away, throwing verbal feces after him or perhaps ripping off a virtual limb or two, the same way a group of chimps will treat a chimp from another group who has wandered into their territory. We've all seen that behavior happening online countless times. Indeed something about being online where we can't see people face to face makes that kind of behavior more common than it used to be back when we had discussions only with people in the same room.
But, if getting your daily fix of agreement from like-minded investors makes you feel good, why should you care? Support is good, isn't it? Especially if it helps you stick to your chosen method of investment and not become one of the dreaded "weak hands" who sell at the wrong time.
And yes, support is good, up to a point, but that support becomes toxic when it turns into cult behavior and makes you demonize anyone who sees things differently from you, or most importantly, distrust or ignore someone who cites facts that you might not know about the company you are invested in or the strategy you have adopted. Conditions change. Even if your initial stock pick or choice of investing strategy was brilliant at the time you made it, when conditions change, new factors may have come into play that you aren't aware of.
Facts also may emerge that might not have been known when you made your original decision, which if ignored can come back to haunt you. If you have been getting most of your information from other people online who share your beliefs, including analysts, it often turns out that some of those facts were actually things someone made up and posted on some message board somewhere which have been repeated so often by fellow investors that they have come to be accepted as truth. So you have nothing to lose and much to gain from examining the factual claims of those who disagree with you.
It is very possible that, after carefully examining their arguments, you will decide they don't provide any reason to change your current strategy. Having done that, you should not feel emotion when you see those same arguments repeated elsewhere. Indeed, you may find that you enjoy reading those who disagree with you because there are things you can learn from their experience and their approach.
I enjoy reading the writings of the best writers among the dividend growth investors, the Bogleheads, the CD community at depositaccounts.com, and those investing in aggressive growth. Over the years, reading all these differing views has widened my understanding of the various options open to me to preserve my assets and provide for the future of myself and my family. Over the years, I have also seen some of the ideas once rejected by these communities gradually become part of accepted dogma within them.
For example, Bogleheads now accept that CDs are a perfectly reasonable alternative to bonds, which was not the case even three years ago. So it is very worthwhile to become aware of how your own tendency to confirmation bias might be threatening your long-term investing success.
In the next episode of this series, we will look more closely at some of the other techniques you can use to ensure that you aren't being blinded by emotional responses that ensure that you see only what you want to see.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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