Post-Election Thoughts: Beware Confirmation Bias

The week before the election, I posted about the conflicting data points that indicated either a Romney or Obama victory was possible.  I noted that the two data points that seemed to me most credible, the Intrade election market odds and Nate Silver’s Electoral College model, both indicated high confidence about an Obama victory.

I confess that my personal hope was that the lower-confidence measures, those indicating a Romney win, would prevail.  That hope was not fulfilled.

There are several lessons here.  The most important is to beware of confirmation bias.  This is the innate human tendency to select, from a complex environment, those facts that confirm your pre-existing beliefs.

For Obama’s supporters, those facts were state polls showing consistent leads in key battleground states, even when national polls showed Romney ahead.  For Romney’s supporters, large and enthusiastic crowds, and a solid lead among Independent voters, appeared to show evidence of an underground swell of support for Mitt.  In the days before the election, serious observers from both camps publicly predicted a landslide for their candidate.

My own suspicion is that both camps were over-confident, and that Hurricane Sandy moved the needle several points from Romney toward Obama, turning what might have been a nail-biter into a comfortable Obama victory.

So what does this have to do with investments?

The first lesson is about the dangers of belief in things we want to happen.  As Warren Buffett often notes, most human beings are possessed of an entirely unjustified confidence in their own predictions.  In truth, we are bad predictors of future events, especially when our perceived self-interest matches up with the conventional wisdom. That is why we rely on value, not prediction, to guide our portfolio strategy.

Confirmation bias can also have a distorting effect on negative investment decisions; we can find support for selling just as we can for buying.  A good example of this occurred early in Obama’s term.  Global stock markets, which crashed starting in September of 2008, right in the middle of the Obama-McCain Presidential contest, made a final low in March of 2009, early in Obama’s term in office.  For some politically-conservative investors, the combination of Obama’s popularity, his perceived socialism, and the market’s plunge to new lows confirmed the necessity of selling out.  As I’ve often noted, that was a life-changing, irrecoverable error.  But for someone already in panic mode, there were any number of confirming signals, especially on talk radio.

Two of our firm’s three Managing Directors are Republicans, one a Democrat.  We were united in our belief that it was foolish to sell, and we shared the suspicion that the market would recover more quickly than most investors expected.   We were right on both counts.

One of our strengths as an organization is that we don’t agree on everything, to the point where sometimes we don’t get along as well as we’d like.  We think that helps us to do a better job of making investment decisions for our clients.  We always ask ourselves, about any investment idea, what is the benefit to our clients if we are right, and what are the risks if we are wrong?

This relates strongly to one of my personal rules for living — the more important the decision, the more important it is to speak to people who don’t agree with you.

I see a more personal benefit from the election results.  If Romney had won, I would have been intensely curious about how he would deal with issues of public policy.  Given Obama’s re-election, I don’t have the same level of interest.  Democratic President and Senate, Republican House, weak economy, massive deficits.  I’ve seen this movie before, and I’m not looking forward to the sequel.

My job is to help my clients get rich and stay rich.  It is a fun and challenging job, doing work for people I like and respect.  The election result helps me put aside the distraction of politics.  As you know if you’ve followed this blog, I don’t think political outcomes have any predictable relationship to investment results.  I’m excited about getting back to several specific investment research initiatives

One thought on “Post-Election Thoughts: Beware Confirmation Bias

  1. Hey Jim. Thanks for all your analysis during the election season. I’ve enjoyed reading your column. As for me – I really felt unclear in terms of the economy. I’m concerned about the debt but couldn’t see how Romney was going to be different than Bush (increase defense spending and cut taxes). So I had to vote based on things closer to my heart – I thinks kids should have health care and I felt Obama had it right on gay rights (certainly having a gay son influences that). So…I wasn’t disappointed in the outcome. But I do hope for the end of gridlock and improves bipartisanship. We’ll see. Charlie Hoffmeister.

    Sent from my iPhone

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