Overconfidence

overconfidence

A close relative to the previously mentioned Confirmation Bias, Overconfidence is the tendency to overestimate our own abilities (i.e., we aren’t as smart as we think we are).  We tend to think that we are much better forecasters and estimators than we actually are.

Any individual is probably suffering from overconfidence due to the human tendency to mis-calibrate probabilities.  It is further fed by the illusory certainty of hindsight.

The good news is—in case you are female—that overconfidence might be more a male trait thanks to their 7-8 higher testosterone levels.

The bad news is–in case you are human–that overconfidence is not counterbalanced by the opposite effect, ‘underconfidence’, which does not exist.

Warning signs for investors are: You take heart from winning investments, but “explain away” poor ones.  You make frequent trades, especially with a discount or online broker.  You don’t know the rate of return on your investments and never compare that to a benchmark.

Did you know the average investor thinks they’re smarter than the average investor?  They tend to attribute their stock gains to smart decisions, while attributing their losses to bad luck. Unfortunately, the opposite is probably true.  The majority of their gains could most likely be attributed to luck, while their losses are more often than not the result of poor decision making.

It’s also easy to confuse skill with a bull market.  A lot of bad decisions can get rewarded when the market is going straight up.  But, when the cake-walk stops, those bad decisions can ruin your portfolio.

Another monetary example is assuming that you have knowledge that you really don’t have.  Someone who is good in math may not take the time to mathematically evaluate the choices.  For instance, a 15 year mortgage on your home is only a little more costly per month than a 30 year mortgage.  The difference in the cost of the total interest you pay is enormous, yet almost everyone gets a 30 year mortgage.  Almost everyone has the skill to compare the two choices, but few take the time to do so.  This kind of stalled thinking can be irresistible, but your wallet will inevitably be lighter as a result.

Or you might think that because you understand “one”,  then you must therefore understand “two”, because one and one make two.  But you forgot that you must also understand “and”.

Daniel Kahneman (the Nobel Prize laureate and pioneer in empirically analysing human errors arising from biases) suggests that one should frown before making a decision.  Frowning apparently increases the vigilance of our “Slow Thinking Mode” and should result in a more logical conclusion, thus overriding intuitive, instinctive and emotional decisions (recommended book “Thinking, Fast and Slow” by Daniel Kahneman).

Stop, slow down, look at the issue at hand from different perspectives, ask a female friend first, and rethink, but be aware that “Thinking is very upsetting.  It tells you things you’d rather not know.”

 

“Well, I think we tried very hard not to be overconfident, because when you get overconfident, that’s when something snaps up and bites you.” — Neil Armstrong

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