What is Hindsight Bias? - An Overview
Created on 22 Sep 2020
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Updated on 21 May 2022
"I knew it!" or, "I told you so," how many times have you said these words or have heard them from others?
Consider this: Your favorite cricket team, batting second, has been given a target which seems to be well within its reach, all wickets are intact, and time is of no consequence. But you have a sneaking fear that despite this, your team may lose. You know that the opposition's bowling is excellent, and you remember occasions when this had happened in a similar situation.
In any case, whether your team wins or loses, at the end of the day, you will always end up saying, "I knew it." This is because you remember you had those doubtful thoughts, conveniently forgetting that you also had the exact opposite thought. This is what is called hindsight bias.
Understanding Hindsight bias
Scientists first identified the hindsight bias in 1975. Researchers believe the reason behind people developing this bias is that once you learn something new, your brain tends to draw connections between that new information and all other things that you already know.
Hindsight bias is the tendency to think that any information is less surprising once you know it. So, your brain suddenly recognizes patterns, which make that new information seem usual and unsurprising.
This is a cognitive bias where individuals tend to believe that they have mispredicted the event. Thus, this bias tends to affect the future forecast of an individual, given that he or she has not learned from their past mistakes. Having this bias can be destructive for an investor, as they sometimes tend to feel that they can predict the market very well.
Hindsight bias psychology
Investors suffering from hindsight bias have some particular characteristics:
- Memory Distortion: This means that investors don't accurately remember their initial judgment or opinion of something. And after the event has already happened, they often say things like, "See, I said that would happen." Researches support the fact that we tend to be selective about memory recall and that we remember information that confirms our preexisting beliefs. We will spin a story to help us understand the information that we have.
- Inevitability: This is saying something like, "It was meant to happen." We trick ourselves into believing in a fixed mindset. We often tend to dismiss important information by just assuming that it was bound to happen.
- Foreseeability: This means that investors think that they can predict the future, which actually, no-one can't.
How Hindsight bias affects your investment decisions?
Consider a hindsight bias example: Imagine you have stock investments. Every day you have to make decisions to invest your money in the best stocks, and that can be hard to predict no matter how good you are at it.
But if you happen to make a bunch of investments that turn out to be a lot more profitable, you might think you earned that success because you are good at it. This might increase your confidence. You start making riskier decisions because your hindsight bias is making you think that you know more than you do.
Now imagine if the same investments have turned out poorly. In this case, you might look down upon yourself for messing things up even when you couldn't have known better.
- Investors who are prone to this bias might have an overestimation of their intelligence or false overconfidence effectiveness of their thoughts or decisions. This can lead the investors to make riskier decisions, which may harm their financial well being.
- This bias might also encourage investors to blame others. The investors can often blame their advisers or portfolio managers for their investments' poor performance and entitle them with praise when their investments earn profits.
- This bias also makes investors label the people who have failed to forecast a situation or an outcome even though the result might generally not be predictable.
- Investors who are suffering from this bias tend to write their judgments and portray it to others as if they have predicted the event.
How to prevent yourself from hindsight bias?
When it comes to problem-solving, hindsight bias tends to make you think the problem or even its solution was more evident than it was. And that often ends up with someone getting too much credit or too much blame.
This can have severe consequences. Being aware of a bias does not immune you from being a victim of it. As an individual, you can do certain practices to avoid the occurrence of this bias.
- Consider the opposite, investors who are seeking only useful information or only insufficient information about any company or investment avenues need to stop for a second before making any investment decision and imagine the exact opposite scenario. If you just think about the fact that other outcomes were possible, you are less likely to assume that any single outcome can be obvious. This way, we don't selectively remember information that just fits in the situation. Instead, investors will have a more holistic and new perspective.
- To keep themselves grounded, investors can also maintain a diary of forecasts that they make on their investments. After this, investors can then observe how their investments perform and then compare them with their projections.
Hindsight bias is the price that we have to pay for the fact that we have hindsight, which is a good thing. Looking back and connecting between things that happened helps us become better and learn from our mistakes.
Hindsight is an excellent tool for planning for the future, but it's worth remembering that hindsight isn't always reliable when it comes to making sense of the past. The biases are an unavoidable part of us, though, so the better we can understand them, the better we can work around them.
It is more dangerous when investors tend to avoid these kinds of mistakes and, thus, have no opportunity to learn and improve. Therefore, we will be discussing some more biases in our upcoming blogs so that you can understand them better.
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