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How to Remove Hindsight Bias from Your Investment Plan

Anyone may feel they are going out of their mind whenever something terrible happens. They look for someone to blame, and the blame eventually falls on whoever ‘should’ have known of the impending threat. The same hindsight bias runs rampant in the investment process. This is why our team highly suggests, for those of you with between $5 million and $500 million in liquid investable assets, that you download the ultimate book we’ve written about financial planning and wealth management for free.

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The insights you’ll discover from our published book will help you integrate a variety of wealth management tools with financial planning, providing guidance for your future security alongside complex financial strategies, so your human and financial capital will both flourish.

Clients frequently share with us how the knowledge gained from this book helped provide them tremendous clarity, shattering industry-pitched ideologies, while offering insight and direction in making such important financial decisions.

When a market crash happens, or a company goes under or falls in value too fast for people to react through market timing, investors look for causes, hoping to use them for future market timing. They regret not having spotted the warning signs while it still could have made a difference. Bias hindsight makes past events look more predictable than they are in fact.

In investing, as Breaking Down Finance puts it, this produces parallel market outcomes. It “deludes us into thinking that future events are more predictable than the fact. This way, hindsight bias tends to make many investors overconfident.” The last thing you want is an overconfident investment manager. You will get more information on how to remove the hindsight bias for your investments on this page.

Hindsight bias might confuse investors from a fundamental analysis of a company. Holding to the intrinsic valuation approach allows them to make decisions based on data and not personally.

Intrinsic value is the understanding of a stock’s real value, which is dependent on all factors of the company which may or may not be the same as the market price.

hindsight bias investing

Studies of Hindsight Bias in Investing

A 2009 study into hindsight bias and investing looked at several cases to quantify the effect of the bias on investment decisions. The overall result was ominous for investors picking their investment managers by drawing names out of a hat:

After being shown the historical volatility, Hindsight-biased investors will continue to underestimate it, and in fact perform worse.

Think about this case for a minute if you have a confident group of people who know how to bet on the stock market. And yet, after being shown real history, real data of market volatility, their investment decision continued as before – assuming a steady increase in stock prices. And their outcomes got continually worse. This is also known as confirmation bias.

For example, the authors studied 66 students at Mannheim University and found that hindsight bias actually reduced the students’ decisions of future market volatility. Then, they saw the data. They understood what caused the previous situation of volatility. This led them to think they understood the problem and could correctly spot them in the future. Thus, since they didn’t see those causes in the world, they operated as if everything would be fine.

Similarly, the authors looked at 85 investors in banks and found that those with greater hindsight bias performed worse. When it comes to hindsight bias, it seems knowledge is not power.

Lessons for Investors Wary of Hindsight Bias

You are just as vulnerable to hindsight bias as many people. It’s an easy trap to fall into, especially in matters and issues you care about most. Such as investing.

Here are three lessons that investors can apply. You look for a financial advisor who will be more likely to avoid letting hindsight bias interfere with his or her decision-making process.

1. You Cannot Rely on Past Events Caused By Hindsight Bias

This holds for both strong and weak events. Investors might look back on a situation of bullish markets, study and discover valid explanations for those trends, and then believe the investors understand what caused them. But even if their understanding is correct – and it’s a fact– there’s no reason to believe that the same situation will produce the same result in the future. But their overconfidence results that they can ‘link it’ next time will actually lead her to make worse investment decisions.

2. You Cannot Rely on Causes of Past Market Downturns

Likewise, investors are studying the causes of market crashes, and downturns are vulnerable to the same overconfidence. Our inability to see things as they really are when it comes to investing must keep us humble. The moment an investor believes she can predict the market timing because she understands something from history, she is a consequence of employing hindsight biases.

And the research above suggests her performance will be worse, not the same, and not better if she persists in that approach.

3. Be Wary of Financial Advisers Who Don’t Consider Market Volatility

One of the best questions you can ask a prospective financial advisor is:

“How do you incorporate market volatility into your financial planning methods?”

Volatility is certain to come. In fact, it happens to investors almost every year in the short term. It’s quite common to observe drops of more than 10% in the same year you see gains of 10%. But it happens over the long term too. The market will not go up every year.

It’s commonly stated that over time, markets always increase. The problem is, how long of a time period must pass before that belief remains true? If you were unlucky enough to retire right before the dot-com crash or the 2008 Great Recession, you gained a whole new perspective about how markets always go up.

Discuss with your advisor how they plan for market volatility. If they have no answer to give you that information, look for another advisor. Stick with partners at your own great peril is not a good decision.

How to Remove Hindsight Bias in Investment Decisions

Can you really beat hindsight bias? Yes, if your advisor has built a process to avoid the consequence of hindsight bias. Here’s how Pillar Wealth Management avoids falling into the problem of overconfidence caused by hindsight bias:

1. Healthy Asset Allocation Tied to the Investors Purposes

Asset allocation with low-cost funds and regular rebalancing, according to Yale Endowment Fund Manager David Swensen, is “the most sensible approach” if you truly want to maximize your long-term investment plan, “You’ll end up beating the overwhelming majority of clients in the financial markets.”

Swensen took Yale’s fund from $1 billion to $22.9 billion in just over 20 years – through two recessions and Black Monday. So he knows a few things. Why is asset allocation so important? Because it helps you keep emotions out of your investment decisions.

The stock market is soaring, you might think, and your portfolio is tilting toward equities because they’re making so much money. “Maybe I should just let it keep growing,” you will be tempted to think (and so will your financial advisor if you have one who gives in to hindsight bias).

But regardless of how well or how badly the market might be performing, you must take that money out and rebalance to the pre-planned ratios of stocks, bonds, and money. If you follow the plan developed based on more than hunches and whims, you will succeed.

2. Don’t Panic When Market Volatility Happens

“Stay the course” is the standard advice here, and you should follow it.

It can be tough to watch your account balances drop during a downturn, but you must keep the long-term view in mind. It will help if you trust the plan and the reasons it was developed.

See a 3-step response plan to market volatility to get more explanations in our book.

3. Employ a Non-Emotional, Data-Driven Financial Planning Process

Here’s where most investors – and most financial planners – fall short.

We’ve mentioned before the importance of trusting the plan. But if your plan isn’t rock solid, then you won’t feel confident in leaning on it when times get tough.

Pillar Wealth Management has developed a time-tested planning process that maximizes performance and tailors the outcome to each individual. Our planning process is why we only work with high net worth investors with a bare minimum of $1 million and up to $400 million in liquid investable assets. It takes all the fear and uncertainty out of your mind. When you contact Pillar Wealth Management (all rights reserved), you are speaking with professionals. Our wealth managers answer your phone calls and respond to emails promptly. We send you regular reports and provide you with online access to your portfolio and other data.

How does it work?

Very briefly, our approach doesn’t rely on projected outcomes, and we do not build your retirement plan around such an unreliable indicator. No one knows how the market stocks will perform in the next twenty years. With the impending uncertainty of climate change, baby boomer retirements, Medicare and Social Security running out of money, and so many other situations we aren’t even aware of – no one can predict where the market will go.

Yet, most financial planners make decisions about future market growth anyway, based on historical averages. It’s not a reliable approach.

Pillar Wealth Management uses a different approach to remove hindsight bias. We begin with historical data going back about 100 years, to before the Great Depression. We’ve analyzed how the market responded to every stress point, every period of growth, every national and world event, every period of inflation, every war, every culture-shifting innovation like the advent of television and the birth of the internet.

With 100 years of data that incorporates the market’s response history to volatility, we then run 1,000 tests through that model – using your custom-designed life-goals analysis as well as your financial portfolio – and watch how they perform.

Each test acts as a hypothetical market-shifting event. Some of them are positive, some negative, and some disastrous. Some more disastrous than anything that’s ever happened in history, such as two back-to-back recessions.

If your portfolio holds up in 75-90% of those ‘What If’ ways, we deem your portfolio healthy, and you can relax. If your confidence level falls outside 75% and 90%, we make targeted adjustments to your plan, re-run the 1,000 tests, and keep doing this until you’re back within the 75-90 range, what we call the Comfort Zone.

Do you see how this approach eliminates hindsight bias? It both removes emotion and forces healthy asset allocation.

Even if markets are plunging, if your portfolio remains within the Comfort Zone – which is tied intimately to your own personal life goals – then you know you’re okay. Even though you fall outside of the Zone, there’s no need to panic. You make a few adjustments until you’ve restored your long-term stability.

There is no consideration given to the specific causes of recent events, media hyperventilating, or how we can better predict the next time. Our approach is one way to remove hindsight biases for the power of the market.

Learn More About Our Hindsight Biases -Resistant Planning Process

I have much more to say about hindsight bias. This was just a quick overview of a very detailed process we’ve fine-tuned and perfected over 30 years of experience as wealth managers.

Want to see if your portfolio lies within the Comfort Zone? Request a free portfolio evaluation meeting, and see if you’re in the Zone. Please do not wait any longer and schedule My Evaluation.


To be 100% transparent, we published this page to help filter through the mass influx of prospects, who come to us through our website and referrals, to gain only a handful of the right types of new clients who wish to engage us.

We enjoy working with high net worth and ultra-high net worth investors and families who want what we call financial serenity – the feeling that comes when you know your finances and the lifestyle you desire have been secured for life, and that you don’t have to do any of the work to manage and maintain it because you hired a trusted advisor to take care of everything.

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