Confirmation Bias

Finding information that confirms our belief

What is Confirmation Bias?

Confirmation bias is the tendency of people to pay closer attention to information that confirms their hypothesis or belief and ignore information that contradicts it. This is a type of bias in behavioral finance that limits our ability to make objective decisions.

 

Confirmation Bias

 

Confirmation Bias Example

Let’s look at an example of confirmation bias:

I have four cards for you (each has a number on one side and a letter on the other side). One of the cards shows an E, one shows a 4 on one face, one has a K on one face, and one has a 7.

I’m going to tell you that if a card has a vowel on one side (like the E), then it must have an even number on the other side.

My question to you is: Which card(s) do you need to turn over to see if I am telling the truth? More specifically, of the four cards, what’s the minimum number of cards you need to turn over in order to see if I am telling the truth.

 

Example of Confirmation Bias

 

What did you choose? Most people will choose the E and the 4. Unfortunately, that’s not the correct answer. The correct answers are actually E and 7.

If you turn over the E, and you find that there is an odd number, you’ve proven that I was lying.

If you turn over the 7 and you find that there is a vowel, then again, I was lying.

By turning over the 4, if there is a vowel on the other side, you only prove that you don’t prove anything, all you do is confirm my statement.

So, why are we biased to choose the 4? Let’s explore that in more detail but in short, it’s confirmation bias.

 

This example is from CFI’s Behavioral Finance Course.

 

Being Prone to Confirmation Bias

We are all prone to confirmation bias. We tend to look for confirming, rather than disconfirming evidence. We have a really bad habit of looking for information, in other words, that agrees with us. We also have a tendency to form our views and then spend the rest of the day looking for all the information that makes us look right. Our natural tendency is to listen to people who agree with us. Because it feels good, it feels all warm and fuzzy to hear our opinions reflected back to us.

I’d like you to think about where you get your news from. If you watch television, what’s your preferred news source? Do you prefer Fox News? Do you prefer CNN? Where do you get your news from? In fact, many of us will choose our news again, based on this confirmation bias.

We choose the news that reflects our views and opinions. However, it is disastrous for investment decision-making. Instead, we should be looking for disconfirming information and disconfirming evidence. It was the basis of Charles Darwin’s work on evolution. Instead of looking for information that just confirmed he was right, he looked for information to disconfirm his theory.

So, start looking for information that actually would possibly disprove your ideas rather than confirm what you want to do. Certainly, that is how you try and guard against this bias.

 

Additional Resources

Thank you for reading this guide to confirmation bias in finance. To learn more, check out CFI’s Behavioral Finance Course.

Additional relevant resources include:

Corporate Finance Training

Advance your career in investment banking, private equity, FP&A, treasury, corporate development and other areas of corporate finance.

Enroll in CFI’s Finance Courses to take your career to the next level! Learn step-by-step from professional Wall Street instructors today.