Hindsight bias – You Knew It Already, Didn’t You?

We always have some clever friends and relatives who claim to know everything beforehand. “See, I knew it all along!” But, do they really?

When it’s July for example. A Mumbaikar notices that it's beginning to look a little bit grey outside. He has a feeling that it's going to rain soon. But despite this, he has second thoughts. Weather can turn around any time. Because its Mumbai rains! When it actually does rain, he tells that he was sure it would when he saw the clouds rolling in earlier. This is the classic game of hindsight bias.

Market Geniuses in Retrospective

To many of us, things always seem more obvious and predictable after they have already happened. This bias tends to affect the future forecast of an individual, because 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.

There were many who thought they knew the 2008-09 crash was coming or all signs were there for the Harshad Mehta scam to happen. But can this kind of thinking harm you? The answer is YES.

Why Is It Dangerous?

Hindsight bias holds the danger of simplistic generalizations and investors tend to fall into its trap easily. Even if there’s enough data indicating that there are many IPOs that fail, the popular view is that IPOs are easy money. And when that IPO lists high, people start telling they knew it all along and how they discovered a gem of a stock. Now, this is not helpful for the investor who must make a choice about the next IPO based on the perception of their ability to predict past events.

The factors that lead a business to success are complex and requires thorough monitoring. If it were so easy to invest in bluechips and simply sit back, relax and see your money grow, then why some of yesterday’s bluechips are laggards of today? Or that some companies are too big to fail, yet they fail?

The same is true in the opposite scenario. Saying I knew it all along that the stock would plunge or something bad was about to happen. Investors who are prone to this bias might have an overestimation of their intelligence or overconfidence of their thoughts or decisions. This can lead them to take riskier decisions, which may harm their financial safety.

How to Avoid It?

In investing, hindsight bias may manifest as a sense of frustration or regret at not having acted in advance of an event that moves the market. Having hindsight isn’t bad. But one must know when exactly to use this tool. Remember no one can predict exactly what will happen from the start.

The key to managing hindsight bias involves documenting the decision-making process via a journal. Get a holistic perspective before you buy or sell any stock. Take into account various scenarios. Do your research well and stay updated on the stock you invest. That way your decisions will not be based on the past experience only.

References: Investopedia

Times of India