Regular readers know I enjoy discussing behavioral aspects of investing. The reasons for this are twofold: First, we can’t control the markets, but we can control our own reactions to it (at least we can try). And second, many studies have shown that investors suffer from a behavior gap between what they should garner in returns and what they actually get.

Of all of the failings of human wetware, the one I find most intriguing is cognitive dissonance. You can find technical definitions at Changing Minds, The Skeptics Dictionary or any number of other reference books.

In the context of economics and investing, my preferred definition is as follows: Cognitive dissonance occurs in the mind of an individual when a theoretical belief system is confronted by factual evidence demonstrating outcomes contrary to what theories dictate should occur.

Stated more plainly, when facts conflict with beliefs people find ways to ignore those facts, rationalizing them in a way that allows the disproven ideas to survive. John Kenneth Galbraith famously referenced cognitive dissonance before it was even called that, stating “Faced with the choice between changing one’s mind and proving that there is no need to do so, almost everyone gets busy on the proof.”

I was reminded of this recently courtesy of several seemingly disparate but cognitively-related articles.  Continues here


Category: Cognitive Foibles, Investing, Psychology

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One Response to “Cognitive Dissonance Is Hurting Your Returns”

  1. faulkner says:

    Cognitive Dissonance is a natural result of our System 1 processes. Already having in mind a clear and vivid image of how something works – call it a belief, theory or ideology – the sincere individual isn’t so much “refusing to acknowledge the complicated reality,” but cannot even see it. Like that famous New Yorker cover showing how New Yorkers see the rest of the country, the further way from the facts, the easier it is to make up a story (out of a few iconic cliche images).

    An advantage of this, as R.D. Laing noted, is we do not easily flop from one belief to another. Our persistence of clear and vivid mental images serves our goal setting, planning and long term commitments.

    The wprld is never what we think it is, and our ideas of the world are often good enough. So, what is curious is knowing when it is useful to question them. When does cognitive dissonance prompt a desire to inquire rather than explain?

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