Overconfidence Bias

Overconfidence Bias

Overconfidence Bias 150 150 Pradan Yeluri

Do you know someone who thinks their sense of direction is much better than it actually is? Or, perhaps maybe, you have a friend who overestimates their singing abilities? The tendency people have to be more confident in their own abilities than is objectively reasonable, is clinically defined as Overconfidence Bias.

This common ego-driven tendency is when a person overestimates their abilities and talents. While it’s important to be self-assured, being overly confident could possibly lead to risky and poor decision making.

Overconfidence Bias can present itself in many aspects of our lives

How does this impact investors?

Overconfidence Bias is surprisingly prevalent across investors. In an environment defined by uncertainty, many people crave certainty, conviction and confidence. This can lead people to overestimate their understanding of financial markets or specific investments and disregard data and expert advice.

Let’s look at an example
Experts are not immune

Remember the famous economist Steve Keen who put his house on the market because he was convinced that house prices in Australia were going to fall 40% in the middle of the Global Financial Crisis? Keen was so sure of his model that he made a bet to walk from Canberra to Mt Kosciuszko if the crash did not happen. He lost his bet. Conceding that he underestimated the impact and scale of stimulus provided, he made the walk in 2010 wearing a t-shirt that said, “I was hopelessly wrong on house prices. Ask me how!”

How do we challenge Overconfidence Bias?

In investing and in our daily lives, taking the time to think of the consequences of our actions could be a great tool for overcoming Overconfidence Bias. Paying attention to feedback and even acting as our own devil’s advocate could also help to manage this behavioural bias. You are the CEO of your wealth. A good leader will surround themselves with people who will challenge their views. An aware, open, and inquiring senior team is critical to sound decision making according to Harvard Professor Max H. Bazerman.

This requires a deep and honest relationship between you and your advisor, where you can discuss truthfully your investing style and how this can be sharpened. Being overconfident in our investment decisions can interfere with our ability to practice good risk management, often leading us to underestimate risk. A financial advisor can help to counter this bias.

A genuinely trusted advisor is a confidant, coach, and guide, someone who is prepared to have a difficult conversation. They can fill in knowledge gaps so you can take a more balanced view before embarking on an investment pathway.

A continuous process of education, analysis, reprioritisation and taking action can over time result in Kaizen, the Japanese business philosophy meaning “continuous improvement.”

At Viridian, our advisors are equipped to help clients become aware of and then manage the inherent biases we all face. By encouraging our clients to think critically about their decisions, an optimal life can be achieved.

Studies:

A US study found that the average man overstates his height by 1.2cm: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC2774635/

Roughly 85 per cent of the sample believed themselves to be above average intelligence: https://www.sbs.com.au/topics/voices/culture/article/2017/07/19/most-people-think-theyre-above-average-intelligencebut-we-cant-all-be-above

94 percent of professors rated themselves above average professors relative to their peers: https://onlinelibrary.wiley.com/doi/abs/10.1002/he.36919771703

Encouraging Dissent in Decision-Making: https://hbswk.hbs.edu/item/encouraging-dissent-in-decision-making

Pradan Yeluri is an Executive Advisor at Viridian Advisory.

This post and some supporting materials may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we may have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product. The material in this post is correct and complete as of the data it was posted. Viridian is not responsible for, and expressly disclaims all liability for, damages of any kind arising out of use, reference to, or reliance on any information contained within this site.

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