A puzzle that was so hard the first time around is simple in hindsight.
This is known as Hindsight Bias.
This week I talk about the psychological phenomenon of Hindsight Bias and investors’ over reliance on Performance Numbers.
Hi Clients and Friends, Mike Brady here. This week I want to talk about Hindsight Bias and why many investors put an overemphasis on past performance. I mean if you’ve been an investor for some time, you’ve probably had that experience where you find a mutual fund that’s had a great track record for three, four, five years, or so, you put your money in then all of the sudden the track record goes right down the toilet. You take it very personal, and I’m here to tell you it is not personal. That person probably put an overemphasis on past performance.
Now, hindsight bias is a group of distortions that are created when we have knowledge of an event that has already occurred. When we remember the past we find it impossible to remember all of the uncertainties that were facing us at the time. We remember a reconstruction of past events based on what actually happened. It makes it seem so much more inevitable, the actual occurrence that happened. Have you ever had that puzzle or that riddle that was just impossible to figure out, and then you figured it out. And then it’s like, “oh, that’s child’s play, that is so very obvious!” Well, you forget that at the time it wasn’t so obvious. It is the same thing as it relates to a kind of a hind sight bias.
Now, in general, I’m going to philosophize here a little bit, I believe that humans and people, and investors, we don’t like uncertainty. I mean, the more uncertainty there is, it kind of reminds us how little we really know. It is very discouraging to understand and to realize how limited our understanding of cause and effect really is. Sir Isaac Newton, talked about cause and effect. And it is very hard for us to understand that sometimes things happen without a very clear cause. And we are always looking for that exact cause to correlate with that effect. And the world, I’m kind of a chaos theory proponent, that the world is a very complex place. And so we’re always looking at a past performance, we’re always looking at data in order to reduce some of our uncertainty as we go in to a particular investment.
There is another study, just kind of talking about from a behavior science point of view, that the more data we have makes us feel better but doesn’t necessarily make the decision we make that much better. There’s one study after another that has shown that. And so what I would recommend is to really talk with that particular manager to find out how he or she makes decisions, how they think, how when some adversity some problem comes before them, how do they approach that problem? What’s their knowledge in the field that they are managing in? They’ve got to be absolute experts in it. But I would also argue, now I’ve said this in previous videos, they’ve got to have a sense of humility. A sense of humility about what they do know and what they don’t know; what are the certainties and what are the uncertainties- an ability to be comfortable in that unknowing place.
That is my discussion this week on the bias and also on past performance- about avoiding putting too much emphasis, almost as if it is a given “past performance guaranteed…future results.” It’s just not true – it’s not just a catch phrase at the disclaimer at the back.
I am a registered representative with Cambridge Investment Research. My company is Generosity Wealth Management. Phone number is 303.747.6455. You have a wonderful week, talk to you later, bye.