The Discomfort of Contradictory Information

When newly acquired information conflicts with our preexisting understandings, we often experience mental discomfort—a psychological phenomenon known as cognitive dissonance. First described by psychologist Leon Festinger in the 1950s, cognitive dissonance occurs when we encounter information that challenges our established beliefs or when our actions contradict what we think we know.

In everyday life:

Imagine you consider yourself an environmentally conscious person, yet you drive a gas-guzzling SUV because you need the space for your family. The conflict between your environmental values and your vehicle choice creates cognitive dissonance. To reduce this discomfort, you might rationalize: “I offset my carbon footprint in other ways,” or “Electric SUVs aren't practical yet.”

In investing:

Cognitive dissonance can cause investors to continue holding losing securities positions that they otherwise would sell because they want to avoid the mental pain associated with admitting they made a bad decision. When market data shows your carefully researched stock declining month after month, the conflict between your original investment thesis (“this is a solid company”) and the current reality (“I'm losing money”) creates significant psychological discomfort.

Rather than face the discomfort of acknowledging a mistake, many investors hold onto losing positions far longer than they should, hoping the market will  eventually validate their original decision. This allows them to avoid the immediate mental pain of admitting errors, even though it can lead to larger financial losses.

The Selective Search for Supporting Evidence

Confirmation bias refers to a type of selective perception that emphasizes ideas that confirm our beliefs, while devaluing whatever contradicts our beliefs. This psychological tendency compounds the challenge of cognitive dissonance by leading us to actively seek information that supports our existing beliefs while avoiding or dismissing contradictory evidence.

In everyday life:

It's quite typical for someone to decide, after purchasing a much-desired item, to look for the same item at a store that is known to have higher prices in order to confirm that he or she made a good purchase decision. This post-purchase validation helps reduce any lingering doubts about the buying choice.

In financial decision-making:

Confirmation bias can cause investors to seek out only information that confirms their beliefs about an investment they have made and to not seek out information that may contradict their beliefs. This behavior can leave investors in the dark regarding, for example, the imminent decline of an investment.

Consider how this plays out practically:

• Underdiversified portfolios: Confirmation bias can cause investors to continue holding under-diversified portfolios. Over the years, I've seen clients become infatuated with certain stocks, seeking only positive news about these companies while ignoring warning signs or broader market risks.
• Company stock overconcentration: Confirmation bias can cause employees to overconcentrate on company stock. Intraoffice buzz about a company's prospects does not justify indiscriminate reliance by employees on company stock. People may unduly emphasize evidence suggesting that the companies they work for will do well.
• Selective research: An investor might join online forums where other believers reinforce their optimism, focus exclusively on bullish analyst reports, and dismiss negative news as “temporary headwinds”; or “market overreaction.”

This selective information gathering creates an echo chamber that reinforces original beliefs, even as objective evidence might suggest a different course of action.

The Potential Cost of Mental Comfort

 While cognitive dissonance and confirmation bias help us maintain psychological comfort, they can lead to costly financial mistakes:

Holding losing investments too long: Rather than acknowledging a poor investment decision, we might continue holding declining stocks, convinced they'll eventually recover. We seek out  any positive news that supports this hope while ignoring fundamental problems with the company.

Overconfidence in familiar investments: We tend to invest heavily in companies we know well—perhaps our employer's stock or businesses in our local area—because familiarity feels safer. We focus on positive aspects we observe firsthand while overlooking risks we might not see.

Ignoring portfolio diversification: If we've experienced success with a particular investment strategy or sector, confirmation bias can lead us to seek information supporting that approach while dismissing the importance of diversification. We remember our winners vividly while forgetting or minimizing our losses.

Recognizing These Patterns in Ourselves

The first step toward informed financial decision-making is to recognize when these biases might be influencing our choices. Ask yourself:

• Am I actively seeking information that challenges my investment thesis, or only looking for supporting evidence?
• When I encounter negative information about my investments, do I immediately look for reasons to dismiss it?
• Have I been rationalizing poor performance rather than objectively evaluating my strategy?
• Do I feel uncomfortable when investment professionals question my portfolio decisions?  

These biases aren't character flaws—they're universal human tendencies that have helped our species survive by maintaining group cohesion and personal confidence. However, in the complex world of investing, they can work against our long-term financial interests.

Moving Forward with Awareness

Understanding cognitive dissonance and confirmation bias doesn't eliminate them, but awareness creates space for more thoughtful decision-making. When facing important financial choices, consider actively seeking contradictory viewpoints, questioning your assumptions, and acknowledging when your psychological comfort might influence your judgment.

Remember, the goal isn't to eliminate these natural human responses. The goal is to recognize them and create systems that help you make decisions aligned with your long-term financial well-being rather than your immediate psychological comfort. 

In our next newsletter, we';ll explore how these insights can be applied practically in your investment approach and discuss additional behavioral patterns that shape our financial lives. The journey toward better financial decision-making begins with understanding ourselves—and that understanding is worth far more than temporary confidence.