Dear Financial Voice Reader,
You may have seen me on the BBC talking about biases in relation to Starbucks. But actually biases stop you making money too.
Do you like to hear you are right? Have you ever ignored facts, and instead picked facts out of context and cherry picked them or some circumstantial evidence? Have you ever to protect your personal credibility been motivated to do these things. Or maybe felt someone who is emotionally invested in convincing you has managed to do so because you had a reason to be persuaded?
That is basically confirmation bias and as a behavioural finance phenomenon I would lecture on this at Oxford University as a Visiting Fellow in Business at Corpus Christi College. This field of behavioural finance has produced Nobel Prize winners in economics no less – it is that important a field of study to the world according to Nobel committee.
Things like the ‘January Effect’ (more returns in January) are blamed on confirmation bias. If you want to know how difficult it is to get rid of try this puzzle I used in one of my Financial Times columns which I took from Thaler’s academic paper:
Your task is to turn over as few cards as possible to verify whether the following statement is true: Every card with a vowel on one side has an even number on the other side. You must decide in advance which cards you will examine. Try it yourself before reading further.
When I give this problem to my class, the typical ranking of the cards in terms of most to least often turned over is A, 2, 3, B. It is not surprising that nearly everyone correctly decides to turn over the A. Obviously, if that card does not have an even number on the other side the statement is false. However, the second most popular choice (the 2) is futile.
While the existence of a vowel on the other side will yield an • Richard H. Thaler is Professor of Economics, Johnson Graduate School of Management, Cornell University, Ithaca, New York. 198 Economic Perspectives observation consistent with the hypothesis, turning the card over will neither prove the statement correct nor refute it. Rather, to refute the statement, one must choose to turn over the 3, a far less common choice.
As for the least popular choice, the B, that one must be flipped over as well, since a vowel might be lurking on the other side. (The problem, as stated here, did not specify that numbers are always on one side and letters on the other— although that implicit assumption is commonly made by solvers.)
So how do we avoid it, given how difficult it is? One answer logically must be to seek out information which disagrees with us. Warren Buffet apparently uses this approach.
Alpesh Patel
www.alpeshpatel.com for a free course to improve your financial literacy
