What is Hindsight Bias?
Hindsight bias is the misconception that one “always knew” that they were right, after the fact, and assume that they possessed special insight or talent in predicting an outcome when actually, they did not. It is an important concept in behavioral finance theory.
Hindsight Bias Example
Consider the 2008 financial crisis or the dotcom bubble of the late 1990’s. If you talk to many people now, they will state enthusiastically about how all the signs were there and everyone knew it was coming. However, if you go back to 2007 or the mid-1990’s, any analyst or investment professional who was screaming that there was a problem at that time was not listened to, in fact, they were laughed at and the markets ignored them.
Learn more in CFI’s Behavioral Finance Course.
How to Avoid Hindsight Bias
In the other behavioral finance articles, we’ve talked about the need to keep an investment diary. We need to map the outcomes of our decisions and the reasons behind those decisions into various quadrants to avoid that limit to learning. The investment diary also helps us mitigate against another bias of self-deception, which again limits our ability to learn.
Hindsight bias really prevents us from recognizing our mistakes. It is why I talk about it as a limit to our learning because we tend to believe after the fact that we knew about it all along.
So, how do we guard against this bias? An investment diary, or mapping outcomes to the reasoning behind our decisions, is a usual way to keep this hindsight bias in check.
Thank you for reading this guide to hindsight bias in finance. To learn more, check out CFI’s Behavioral Finance Course.
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