Motivated cognition – we believe what we want to believe. We will also believe based on who we are and who we want to be. Our goals and needs shape our thinking. Facts do not change our goals when we have motivated cognition. Investors rationalize and filter evidence presented to support their views. Motivated reasoning will generate confirmation biases.
This type of cognition can actually be effortless and is pervasive with many. Following what we want to believe is not hard work. The hard work is looking at evidence without bias. Motivated cognition is also goal-orientated. We look for evidence to support our goals. It focuses on confirming what we already know and meeting current objectives. It can be very impactful because it can lead to significant mistakes in judgment. If we have a large equity allocation, we will look for evidence that supports this position and dismiss information that contradicts this position. Our cognitive focus is driven by our desire to be right. It focuses our attention on information that supports what we want to happen not what will actually happen.
The power of research is to break the motivated cognition of what may not be true. Evidence-based investing focuses on the likelihood of events and not the desire for events to occur. The key goal for research is to present likelihoods and support positions. It is easy to say that investors should break through their motivated cognition, but much harder to implement.
The use of a systematic and disciplined investment and research process is an effective way of reducing the confirmation biases by making the decision process explicitly based on a set criteria that can be tested. Decisions rules can be tested against past data and reviewed against future performance. There may still be biases based on the weighting of the evidence, but a systematic process can allow for testable analysis. Systematic investing can eliminate one of the key psychological problems facing investors.