Have you ever clung to a belief even when the facts were staring you in the face, suggesting otherwise? This episode dives deep into the 'Conservatism Bias,' a mental trap that can keep us from updating our views when new data rolls in. See below for a written transcript.
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Why that financial analyst ignored recent market shifts and stuck with a too-rosy prediction.
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Transcript
Welcome! We are excited to be able to continue our educational series on biases. This week we will be exploring the Conservatism bias.
Conservatism bias is a cognitive bias that leads individuals to be overly cautious or slow in updating their beliefs or judgments when new information becomes available. In other words, people tend to cling to their existing beliefs or prior information and are reluctant to revise their views even in the face of contrary evidence.
Conservatism bias can influence various aspects of decision-making, including financial judgments, forecasting, and problem-solving. It can hinder individuals from fully incorporating new information into their decision processes and may lead to suboptimal outcomes.
Let’s look at an example of conservatism bias.
Imagine you are a financial analyst responsible for predicting the revenue of a company for the upcoming year. You have historical financial data and various forecasting models at your disposal to make the prediction.
In the past, the company's revenue has experienced consistent growth, averaging around 10% annually for the last five years. However, this year, external factors like economic uncertainty, market volatility, and competition have arisen, which could potentially impact the company's growth.
Despite the new information and changing market conditions, you have decided to stick with a conservative estimate of 10% revenue growth for the upcoming year. This estimate is anchored on the historical average, and you are reluctant to adjust it significantly, even though the current circumstances may warrant a more cautious forecast.
In this example, the analyst's reluctance to adjust the revenue growth estimate, despite the changing market conditions, demonstrates the influence of the conservatism bias.
Let’s look at some reasons why investors may experience Conservatism bias?
1. Risk aversion: Investors are often risk-averse, preferring to stick with familiar investments or strategies rather than taking on new or uncertain opportunities.
2. Confirmation bias: Investors may seek out information that confirms their existing beliefs or initial investment decisions. They may be reluctant to update their beliefs even in the face of new contradictory evidence.
3. Anchoring: The conservatism effect can be influenced by anchoring, where investors anchor their beliefs or expectations on past information or experiences and are slow to adjust them when new information becomes available.
4. Emotional attachment: Investors may become emotionally attached to their initial investment decisions, leading them to be conservative in updating their beliefs or taking corrective actions.
5. Regret aversion: Investors fear the regret of making a wrong decision. They may be hesitant to revise their beliefs if it means admitting they were wrong in the past.
6. Cognitive effort: Changing beliefs or updating expectations requires cognitive effort and mental processing. Investors may prefer to conserve mental energy by sticking with their existing beliefs.
7. Loss aversion: The conservatism effect can be related to loss aversion, where investors are more sensitive to losses than gains. They may be conservative in their decision-making to avoid potential losses.
What can investors do to overcome the Conservatism bias?
1. Stay updated with new information: Continuously seek out and stay updated with the latest information, data, and developments relevant to your decisions. Being well-informed can help you make more accurate assessments.
2. Question your assumptions: Regularly question your assumptions and beliefs. Be open to challenging your own views and consider alternative possibilities.
3. Consider diverse perspectives: Seek input from others and consider different viewpoints, especially from those with varying expertise or experiences. This can provide a more comprehensive view of the situation.
4. Avoid anchoring on past data: Be cautious about overly relying on historical data or averages. Consider whether current circumstances warrant adjustments to your predictions or decisions.
5. Update your beliefs incrementally: Instead of making radical changes, consider updating your beliefs incrementally as new information emerges. Gradual adjustments can help you avoid sudden shifts due to extreme reactions.
6. Use probabilistic thinking: Frame your predictions or decisions in terms of probabilities rather than absolute certainties. Recognize that outcomes can fall within a range of possibilities.
7. Be aware of emotional influences: Be mindful of emotions that may lead to conservatism bias, such as fear of change or a desire to maintain the status quo. Make decisions based on objective reasoning.
8. Develop decision-making frameworks: Establish decision-making frameworks that incorporate both historical data and current information. This can help guide your approach to making decisions more systematically.
9. Encourage feedback and review: Seek feedback on your decisions and review their outcomes. Learn from any biases that may have influenced your choices and use them as lessons for future decision-making.
10.Stay flexible and adaptable: Be willing to adjust your predictions or decisions as new information becomes available. Embrace a growth mindset that values learning and adapting to changing circumstances.
By implementing these strategies, you can reduce the impact of conservatism bias and enhance the quality of your decisions. Being open-minded, seeking diverse perspectives, and basing decisions on a balance of historical and current information will lead to more accurate and informed choices.
This concludes the second of our educational podcasts on biases.
🎙️ Unlock Better Decisions: The Conservatism Bias & You