Less Is More: How Overconfidence Can Hurt Your Returns
Being great at something usually involves a heavy dose of overconfidence. Whether you’re shooting a buzzer beater, making the closing argument in a big case, or performing brain surgery, having the confidence that you’re one of the best can be critical to achieving success.
If I have to go under the knife you better believe I want the best surgeon possible. One with a huge ego and supreme self-confidence. This is obviously preferable to having a surgeon who is unsure of his ability to successfully operate. The same can be said for many other professions where most would agree that they want an individual who’s extremely self assured.
CONFIDENCE ISN’T ALWAYS BAD
You can argue that a big ego and overconfidence are requirements to becoming great or you could argue that becoming great leads to overconfidence and a big ego. Chicken or the egg first? I don’t know. Either way, I know that they often go hand in hand with society’s high achievers. In that way, it’s clear that being highly confident in one’s own ability is a positive thing.
However, that same overconfidence which helps one excel in a given area, can lead to very negative outcomes when projected into other areas, specifically investing. In fact, it seems as though society’s most accomplished are often the worst when it comes to investing.
WHEN OVERCONFIDENCE AND MONEY MEET
Overconfidence can impact investors negatively in many ways. The overconfident investor usually sees other investors as making decisions based off feelings or intuition, while seeing their own investment decisions as a result of rational and objective analysis.
Overconfident investors tend to have a confirmation bias where they see only that evidence which supports their position, while ignoring evidence to the contrary. More tangibly, overconfidence in investing often leads to:
- Being concentrated in too few positions
- Frequent trading due to a belief that they can time the market
- Selecting high-cost, actively managed mutual funds because they believe they can pick one of the few future out-performers
- Investing in high risk ventures because they deem the risk to be lower than it really is
- Holding onto poor investments so as not to realize the loss
- Not seeking the guidance of someone with more experience and expertise
THE MONEY MINDSET
Overconfidence is just one of many behavioral and mental traps investors need to be cautious to avoid. I’ll be addressing other traps in future blog posts given how much investor psychology and behavioral biases can impact having a successful investment experience. As humans, we’re designed at our core to survive.
The instincts, emotions, tendencies, and mental shortcuts that have served us well as a species serve us no favors in the world of investing. The first step in avoiding these traps is knowing what they are.
If you’d like to discuss your investments, or any other financial topic, please get in touch.