Wednesday, September 17, 2008

20/20 Hindsight

Most of us have heard the phrase 20/20 hindsight. It refers to the fact that we tend to view past events as inevitable even though we didn’t see them coming in advance. Another name for this is hindsight bias.

In his book, Your Money & Your Brain, Jason Zweig describes brain-scanning experiments that look for the biological basis for some of our human quirks. One of these quirks is hindsight bias.

When we learn something new, we have a tendency to begin to believe that we’ve known it all along. When we buy a stock that later rises, we tend to think that we knew the stock would go up. We come to think that we bought the stock confidently knowing it would go up when the truth was that we were probably very uncertain and almost made a different choice.

This tendency to believe that we were able to predict past events before they happened is very dangerous for investors. It makes us believe that the future is much more predictable than it really is.

Hindsight bias can even kick in on missed opportunities. Even if you just considered buying a stock, but didn’t buy it before it shot up can make you say “I knew it.” This feeling that you knew the stock would go up makes you more likely to throw money at the next stock that looks like it might rise.

The next time you think about some past event as having been inevitable, try to remember what you really thought before the event occurred. If you’re honest with yourself, you’ll likely remember that you really didn’t know what was going to happen.

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