Understanding Hindsight Bias, its Causes and How to Overcome

Summary:

Hindsight bias is the tendency to look at an unpredictable event with the view that it’s easily predictable. The wide availability of information, memory reconstruction, and the urge to reduce discomfort result in hindsight bias.

When stock markets tumbled after the World Health Organisation (WHO) declared Covid-19 as a pandemic, a part of 40-year-old Rohit was rejoicing. An avid stock investor, he proclaimed proudly to his peers that he knew this was on the cards. Rohit belongs to that breed of investors who tend to look at a particular event in the present and feel that they had successfully predicted it in the past. This tendency is known as hindsight bias.

What is hindsight bias?

Hindsight bias is a psychological phenomenon where you tend to believe after the occurrence of an event that it would happen all along. It is also known as the ‘I knew it all along’ effect, and to put it another way, it’s like saying, ‘ I knew this would happen’ after something has already happened, even though, in reality, it’s not.

A hindsight bias example

Suppose you’ve been following the stock of a tech company for some time. The stock’s increasing value prompted you to invest in it and genuinely believe it would continue to do well. However, when the company releases its disappointing earnings report, the stock’s price falls, and you lose significant money. 

This is where hindsight bias comes into play where, following the decline in stock’s price, you look back at your decision and say to yourself that you knew you shouldn’t have invested in that stock as its earnings were bound to be weak. However, in reality, before the declaration of the earnings report, you believed it was a good decision to invest in the stock.

In the past, events like the dotcom bubble of the late 90s or the 2007-08 financial crisis brought to the fore this bias. You would find several investors saying today that they knew what would happen. Reality, however, is when experts gave the warning signals, most ignored them. 

What causes hindsight bias?

Hindsight bias results from several factors that influence how our brains process information. Some of the primary causes of this are:

• Memory reconstruction

As humans, we have a dynamic memory that’s subject to change. When you look at a past event, the brain may unconsciously modify your memory to align it with what you know. This alteration leads you to believe that you knew that a particular event would happen. The fact, however, is that you didn’t have any knowledge of it.

• Wide availability of information

After the occurrence of a particular event, especially in stock markets, information flies thick and fast. You have more access to info on the event than before, making it appear that the outcome was foreseeable. That said, this information is not available when you initially based your investment.

• Reduce cognitive dissonance 

It is the feeling of discomfort when you hold on to a conflicting idea. Hindsight bias is a mechanism that reduces cognitive dissonance. Through this, your mind may try to convince you that you had predicted an outcome, bringing down discomfort levels.

Also, as humans, we are naturally inclined towards bringing closure to an event. With hindsight bias making you feel that you had successfully predicted the event, it gives you a sense of event closure, thus freeing you of unpredictability.

How to overcome hindsight bias?

Here are some ways through which you can overcome hindsight bias:

• Recognise it

The first step towards eliminating hindsight bias to recognise that it exists. Only when you acknowledge its existence can you proactively combat it. 

• Embrace uncertainty

Accept the fact that stock markets are uncertain. Even the most seasoned investor cannot predict how markets will behave. Several factors influence markets, most of which are beyond your control. By embracing uncertainty, you can avoid overconfidence in predicting events.

• Stay informed

Information and knowledge will help you make more informed decisions and limit hindsight bias, which hinges on limited information. Reading and following financial newspapers and news channels will help you stay up-to-date.

• Reflect on past instances of hindsight bias

Analyse past events when you fell victim to hindsight bias and see how it affected your investments and decision-making. Reflecting on these events can help you stay cautious and make logical decisions going forward.

• Seek expert opinion

Expert guidance goes a long way in the successful navigation of complex situations. Their insights can provide a more balanced perspective of things and help mitigate the effects of hindsight bias.

In conclusion

By being open-minded, you can overcome hindsight bias. The next time you find yourself saying, ‘ I knew this all along,’ take a moment to pause and reflect if this bias is in play.