How often do you look back at something and believe that you could have predicted it, or that the event seemed so obvious only after it has actually happened? If you fall into this line of thinking, you may display what is known in psychology as hindsight bias, a potential decision making killer.
Perhaps the most common occurrences of hindsight bias are immediately following a market crash when many investors believe that they should have been able to recognize that a downturn was imminent. This begs the question: just how accurate are those that display hindsight bias at predicting the future? It appears, not accurate at all. In a 2008 study, economists discovered that investment bankers in Frankfurt and London who exhibit hindsight bias underperform in the financial markets relative to those that do not display this bias. One explanation is that these bankers failed to learn from their mistakes and tried to predict the markets based upon past experiences. This resulted in poor portfolio and risk management choices.
Fortunately, there is a way to avoid falling victim to your own thinking. That is, always lay out an investment plan before you invest. An investment plan will keep you on track—during good economic times and bad—with meeting your financial goals rather than leaving your financial security to chance.
About Christopher Jones
Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.