Behavioural finance: Cognitive dissonance


In any investment category there is invariably a broad spectrum of views, many of which are in outright opposition. This article by Nick Armet, Investment Director, Fidelity Worldwide Investment, looks at the behavioural problems stemming from dissonance and suggests some practical workarounds for investors.

‘Driven by hunger, a fox tried to reach some grapes hanging high on the vine but was unable to, although he leaped with all his strength. As he went away, the fox remarked, “Oh, you aren’t even ripe yet! I don’t need any sour grapes.” Aesop, ‘The Fox and the Grapes’.

Cognitive dissonance is the feeling of discomfort we have when faced with holding two or more conflicting thoughts, beliefs or emotions. Given the human desire to avoid mental discord, we have a strong motivation to rationalise conflicting thoughts away so that we are left with a harmonious, unified view.

The problem is that in order to reduce the dissonant feeling we can become biased to self-deception. We can be drawn into simplifying narratives or illusions or become guilty of rejecting valid but contrary viewpoints out of hand.

While the term ‘cognitive dissonance’ is modern, the principle behind it is reassuringly old. Aesop’s fable of the ‘The Fox and the Grapes’ is one of the earliest expressions of the desire to rationalise away two incompatible truths. When the fox realises he cannot reach the grapes high on the vine, he decides he does not want them after all – explaining the about-turn to himself with the new thought that they are probably sour anyway.

American psychologist, Leon Festinger took up the thread of this fable in the 1950s when he conducted several experiments that subsequently established him as the father of modern cognitive dissonance theory. He put forward two ideas: first that we are motivated to reduce dissonance in our thinking; second that we will actively avoid information which would increase dissonance.

Festinger conducted a famous experiment in which people were asked to perform a monotonous task (turning 48 square pegs in a board clockwise). Some were then asked to perform a favour for the experimenter by telling the next participant, who was actually a researcher, that the task was extremely enjoyable. Half of the subjects were given $1 for performing this favour, while the other half received $20. Dissonance was created by the fact the task was evidently very boring.

Festinger found that those paid $1 reported the task to be much more enjoyable than those paid $20. The only explanation for this was that those paid the smaller amount of $1 were forced to reduce dissonance by actually changing their opinions of the task so this could sit well with the fact they were reporting it as enjoyable.

Festinger’s theory has subsequently been supported by modern MRI brain scanning experiments which confirm that certain parts of the brain (especially the arterior cingulate) light up to signal conflict, and the extent to which these brain cells light up is consistent with the amount of dissonance a person feels.

The scope for mental conflict in investment is obvious. On any investment category or security, there is invariably a broad spectrum of views, many of which are in outright opposition. Indeed, the sheer amount of information available today means there is also considerably more fuel for disharmony to rear its head, making the problem of cognitive dissonance more acute than ever.

Moreover, the financial crisis put us into unchartered territory with unprecedented monetary easing and high debt levels polarising economists’ views on the need for growth versus austerity and the prospects for inflation or deflation.

If there is uncertainty in terms of where we go next, there is also complexity when it comes to what to invest in. A related problem to cognitive dissonance is the Paradox of Choice – a theory put forward by American psychologist Barry Schwartz which claims that, after a certain threshold is reached, an increase in the number of choices may cause psychological distress. In turn, this can lead to something called buyer’s remorse.

This is the sense of regret that flares up after a purchase decision which involved a choice between several valid options. It can be associated with the purchase of an item such as a car or a house or an investment in a particular asset, fund or security. It is an example of post-decision dissonance, where a person seeks to decrease their discomfort to a made decision. The buyer may change their behavior, their feelings, and their view about the world. The dissonant feeling can lead to self deceptions to restore harmony that can make us irrationally overconfident of the investment position we have taken.

Cognitive dissonance is something of a root bias within behavioural finance that can lead to a range of other self-deceiving biases such as narrative fallacy, confirmation bias, overconfidence, and the illusion of control. It can make us unwilling to sell out of a losing position or unwilling to review a position that no longer looks quite as attractive as it once did.

So what are some practical workarounds for investors? First, by undertaking careful research and scenario planning, we can set out an investment policy and process that takes account of various scenarios that we want to give weight to. As with all behavioural biases, investment process is a key defence.

Second, there should be recognition that in investment, it is valuable to search out and weigh up discordant thoughts or views. By deliberately taking the opposite view we can test the strength of our assumptions – if you are bullish, take time to understand the bearish view and vice versa.

Despite the fact that it increases dissonance, investors should be prepared to occasionally fight their emotions by embracing the contrarian view when the market pendulum swings too far in one direction. This means going against the herd by taking profits when everyone is buying and valuations are stretched. And it means buying when the herd is selling and stocks are cheap.

We know that in investment markets, incompatible and opposing views, scenarios and market patterns are commonplace so the scope for dissonance to take root is significant. Indeed, successful portfolio diversification across assets is only possible if you are able to embrace opposing views and scenarios, so that your portfolio is exposed to growth but also resilient to slowdown.
Multi asset products can offer a simple and effective way of dealing with discordant scenarios and views. By investing in a range of safe and risky investments with different risk and reward characteristics, we can avoid the binary pain – or ‘buyers remorse’ – associated with putting too much of our firepower in one asset class.

Stock markets regularly act in unexpected ways – this can also stimulate dissonance. One example is when share prices diverge from fundamentals. This happened in the 2009 ‘trash rally’ when the fundamentally worst, most beaten-up stocks in the market – including financial companies with the highest leverage on their balance sheets – subsequently performed the best when concerted policy actions were announced and market sentiment turned positive.

This is incompatible with the idea of picking the most fundamentally attractive companies, but we can take solace from the fact that such phases are rare and stock fundamentals tend to win out in the end. In the long run, it’s the strongest companies that attract a premium. Again, adherence to investment philosophy is a valuable defence against dissonant views and emotions.

Lastly, consider also the huge monetary stimulus undertaken by central banks. Most recently, the Bank of Japan surprised the markets by announcing its intention to double its monetary base as part of an aggressive monetary policy to target inflation. Since that announcement, the gold price has fallen when many investors would have expected it to rise.

The two things seem incompatible. Is gold reacting to a better outlook for economic growth and ultimately higher real interest rates? And if that is the case, then why are bond yields still near record lows? The scope for dissonance in the present financial markets is evident and the lure of applying simplifying narratives easy to fall into. Disentangling the implications demands a continuous and disciplined fundamental research effort that relatively few investors are able to manage.

1. Festinger, L. (1985. (first published 1957)), ‘A theory of cognitive dissonance’, Stanford, CA: Stanford University Press; Festinger, L., & Carlsmith, J.M. (1959), ‘Cognitive consequences of forced compliance’, Journal of Abnormal and Social Psychology, 58(2), 203–210.
2. Schwartz, Barry (2004), ‘The Paradox of Choice – Why More Is Less’, Harper Perennial.

The views and opinions expressed in this article are those of the author and may not necessarily represent the views of Fidelity.  This article is intended for information purposes only and should not be construed as a recommendation for any investment.
Prior to making an investment decision, retail investors should seek advice from their financial advisers. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise.


  • Raymond_Griffin says:

    This is a great paper – really enjoyed it!

    The contrarian views of markets, economies, trends and the like are often sub-consciously blinkered from consideration by advisers who belligerently hold onto their views of the world. An unconscious (or conscious) barrier to considering alternate views can be to the detriment of clients.

    We often think of behavioural finance in relation to investors however professional advisers are not immune from the deleterious aspects of it.

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