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COGNITIVE DISSONANCE

The next phenomenon is known as cognitive dissonance. The theory of cognitive dissonance states that when we hold two conflicting beliefs in our minds, the discomfort caused by this conflict drives us to acquire, or even invent, new thoughts or beliefs, or even modify current beliefs, in an attempt to relieve the conflict we feel.

If there is a discrepancy between what one already knows or believes, and new information that comes to hand, discomfort is felt (dissonance). And in order to relieve this discomfort, we either invent or modify (or rationalise) our thoughts to eliminate the dissonance that exists.

OK, now for an example, as this can be confusing without one. Suppose you are told by a friend who is a car expert that you should buy a Holden Commodore ahead of a Ford Falcon, as it is the better car in your friend’s opinion. However, after having bought the Holden, you come across some new information that persuasively concludes that the Ford is the better buy. As a result, we have conflicting cognitions in our head, which causes us discomfort, and to alleviate this discomfort, what we as humans tend to do then is to filter out this new information and seek out support for our preferred belief. Obviously, once the car purchase has been made, the preferred belief is that your car is the better one.

Clearly, cognitive dissonance is not too dissimilar to confirmation bias. We tend to seek out information that reinforces our original view, and the basis of why we do this is the classic human fear… the fear of regret. This phenomenon actually has a name in the world of car and property purchasing… buyer’s remorse.

So cognitive dissonance initiates a form of self-deception, and this occurs in the world of investing too. So often, investors buy a stock and upon learning subsequent information contrary to their original view, they distort, manipulate or ignore this new information so as to relieve the discomfort caused by the conflicting views in their heads.

It remains critical as an investor to constantly re-evaluate positions and views and change them as situations require and new data becomes available. It is inevitable that investors are going to make mistakes when forecasting the future. The good investors will minimise the financial damage done by such errors and the poor investors will fail to minimise the damage and this can lead to a small number of errors causing large losses.

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