Cultural Influences on Financial Decisions
February 12, 2025
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The vast majority of investors fail to perform well in the stock market because of behavioral and emotional reasons. The presence of financial knowledge or the lack of it does not make a huge difference. Instead, it is the behavioral biases that turn out to be the crucial deciding factor.
Hence, it is imperative for investors to actively search for biases that may be deep-rooted in their thinking philosophy, and they make attempts to weed them out. In this article, we will have a look at how confirmation bias works and how it impacts investment behavior.
Let us start by understanding what confirmation bias really is. Confirmation bias is the tendency of human beings to actively search for information that matches with the preconceived notion that they have. Individuals tend to pay an excessively large amount of attention to the information which confirms their beliefs. At the same time, they tend to discredit any information that does not conform to their belief.
It needs to be understood that the investor is not doing any of this consciously. Instead, the entire process takes place subconsciously. Investors tend to hold a belief which is often not the result of due diligence. The mind of the investor automatically seeks out information that helps confirm the belief while shunning away information that contradicts it. The problem with confirmation bias is that the investor feels as though they have done the required due diligence even though they really haven’t
Human beings are always searching for inner harmony. This means that they want their beliefs to be harmonious. Hence, if any person is holding conflicting beliefs at any given point in time, it becomes their innate nature to choose one belief. Then they start choosing facts that support their beliefs. This is done by them subconsciously in order to avoid cognitive dissonance. Confirmation bias is a deep-rooted evolutionary behaviour that allows human beings to maintain their sanity.
Confirmation bias affects decisions in all walks of life. However, it has a profound effect when it comes to financial behavior. Some of the main distortions caused by confirmation bias have been listed below:
Avoiding confirmation bias can be tricky. However, it is possible. The trick once again is to first realize that there is the possibility that one’s thinking may be biased. Half the battle is one when an investor starts to doubt their thinking and acknowledges the possibility that he/she may be flawed. Some other steps that can be taken are as follows:
The bottom line is that the confirmation bias can cause significant distortions in the thinking of the investor. These distortions can then also lead to serious financial consequences.
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