This Bias Can Cost Us in Many Aspects of Life
The behavioral biases we’ve been covering in recent posts certainly affect our decision making processes in financial affairs. There’s also impact in other areas of our lives, and this is especially the case with today’s topic. Psychologists have named this bias self enhancement, but most of us would readily refer to it as overconfidence. Self enhancement is the tendency to attribute positive qualities to one’s self and to take credit for one’s successes, whether or not these are accurate beliefs. Overconfident investors will attribute past success to their own skill and reject the role of fortuitous timing or other factors in those outcomes. Conversely, these same people will blame their failures on factors outside of their control.
A common example of self enhancement is found in people’s assessment of their driving abilities. Most people rate themselves as “above average” drivers while rating others as “below average” drivers. Obviously, it’s impossible for everyone to be above average in any endeavor and so it goes for investing. Garrison Keillor poked fun at this behavioral tendency for many years on National Public Radio’s “Prairie Home Companion”. The long running show was set in mythical Lake Wobegon “where all the children are above average.”
Overconfidence in investing comes to the forefront during bull markets. The overconfident investor will attribute profits to his/her stock picking skills when in actuality, the rising market lifted many, if not all of the stocks. Day traders were heavily victimized by overconfidence during the Tech run-up in 1997-2000 and many suffered enormous losses when the bubble burst. This pattern seems to repeat itself with every subsequent market run-up.
When investors attribute all of their successes to skill and conversely, all of their losses to a fickle market, they will never be able to develop a true understanding of how the financial markets actually work. Recognizing and overcoming one’s self-enhancement and self-serving biases can be a major step in improving one’s investing skills. An honest and objective analysis of past successes and failures. measured against a backdrop of how the general market performed during those periods is critical. After all, just as we all cannot be above average drivers, we cannot all be above average investors.
If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.