We often misjudge ourselves and overestimate our abilities. In a word, we are overconfident. If you are confident that you are not overconfident, then I would suggest that you might want to keep reading!
One of my favorite examples of overconfidence was a survey where a group of people was asked to rate their driving abilities. Approximately 90% of the respondents rated themselves as above average drivers! It doesn’t take a Ph.D. in statistics to know that this is statistically impossible (unless, of course, you live in Lake Wobegon). In Why We Make Mistakes, author Joseph Hallinan said it well: “Almost all of us walk around with the private conceit that we are better than average.”
My apologies to my male readers, but Hallinan went on to point out that studies show that men, on average, tend to be more overconfident than women. He referenced one study where people had to estimate their IQs: Men almost always overestimated their IQs and women almost always underestimated their IQs. This overconfidence is particularly prevalent in male-dominated fields such as the military and finance. Unfortunately those are areas that have incredibly serious consequences to overconfidence.
In my experience, a propensity toward overconfidence starts at a young age. As a Little League coach, I witnessed the overconfidence of a child predicting a home run as he walked up to the plate. At those times, I chuckled to myself, thinking a more realistic goal would be to simply hit the ball. But at times as adults, that “I’m going to hit a home run” syndrome causes us to overestimate our capabilities.
For financial decisions, overconfidence can trick us into believing we can hit a financial “home run” by identifying the next “sure thing.” For example, the buzz around Facebook could lead you to conclude that Facebook is a sure thing. Here are some telltale signs that you may be falling victim to financial overconfidence:
• Practicing market timing
• Concentrating assets in one or a very limited number of holdings
• Abandoning investment disciplines, such as diversification
• Never establishing, or deviating from, a sound investment strategy
When it comes to your personal finances, overconfidence can cost you dearly. Fortunately there are things that you can do to help counter your natural tendency to be overconfident and help you be a better investor and make better financial decisions. We will cover a few of these items in future posts.