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Hindsight Bias

  March 17,2020

All about ‘I Knew It’ Bias

Do you get the feeling that you always knew how a situation is going to unfold? Well, it is not uncommon to feel that way. Most people assume that they could predict the outcome. However, we make many predictions. This is a common bias that most of us suffer from.

It is called hindsight bias. Examples of hindsight bias are prevalent in our day-to-day lives as well. Hindsight bias also plays an active role in investing.

E.g., if you buy a stock and the price falls, you may think that you had an inkling that the price of the stock would fall.

What Causes Hindsight Bias?

Our memory is the real cause of hindsight bias. We don't have a perfect memory. After a situation has occurred, we tend to construct an image with the bits and pieces that we like to believe in. As a result, we sense that we could foretell what was about to take place.

Besides, it is easier to remember the outcome than the other possibilities. As a result, we tend to overestimate our capability to predict the outcome.

Overconfidence bias also leads to hindsight bias.

What are the effects of Hindsight bias?

Hindsight bias can harm our investments. Hence, it is important to understand the effects of hindsight bias. Here are some of the impact of hindsight bias on your investments.

Overconfidence:

Overconfidence bias is one of the reasons behind hindsight bias. As a result, investors get a false sense that they know everything about the situation.

When our stock picks get right or our choice of mutual funds perform well, we start believing that we have excellent investment choices. As the trend continues, it leads to overconfidence in our investing skills.

However, at the same time, we ignore the investment choices that we got wrong. We only focus on our choices that went right.

Because of the overconfidence and believe that we could predict the outcome, we tend to take more risk and make irrational investment decisions in our investment. Taking a higher risk than required can adversely affect our investment portfolio.

Remember only the expected outcome

We only look for expected outcomes. As investors, we do not plan for unexpected events. Also, we rarely remember small events that hurt our portfolio.

Not planning for the different possible outcomes can shock us. Hence, it is important to consider all the outcomes and take precautionary measures.

How to overcome hindsight bias

Here are some of the ways that can help us to overcome hindsight bias.

Being aware of the hindsight bias

Acknowledging hindsight bias is the first step to win over this bias. Before coming to any conclusions, it is better to consider the different perspectives and not just look for reports that reinforce what we already believe.

Learn from the mistakes:As investors, we all make mistakes. However, it is important to understand why the investment decision was a mistake and understand the aspects that we might have possibly ignored earlier. We should also check the performance of all our investment decisions.

Don't be overconfident:

As overconfidence is one of the main reasons behind hindsight bias, we need to be practical about our investment skills. Overconfidence also prompts us to take risky investment decisions. Hence, it is important to know our risk tolerance and take investment calls accordingly.

Plan for unexpected events:

Taking precautionary measures or planning for other possible outcomes can help us to avoid shocks in our investments.

Have an investment diary:

As investing is a mind game than a number's game, it is extremely to understand the reasons behind a particular investment choice. So, after every move, noting down the rationale and its outcome will help us to get rid of our investment bias.

Conclusion:Hindsight bias is known as 'knew-it-all-along' bias. According to hindsight bias, investors tend to believe that they had predicted the outcome before it became a reality. As investors, we only remember the right choices and ignore the wrong ones. To overcome this bias, we need to expect the unexpected outcomes, keep an investment diary, learn from the mistakes etc.

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