If you’re like most people, you probably think of yourself as a reasonable, informed person in any given situation. But get this: research shows that most of us are woefully overconfident in our abilities—especially regarding investing. Overconfidence is one of the most common cognitive biases we experience daily. And when it comes to your stock portfolio, overconfidence can significantly impact your bottom line. Thankfully, becoming aware of your overconfidence bias can help you overcome some pitfalls.
What is overconfidence bias?
Overconfidence bias is a cognitive bias that refers to the tendency of people to have an excessively optimistic view of their abilities. When it comes to finances, this can lead you to take on too much risk, make suboptimal decisions, and generally underestimate the importance of luck.
Overconfidence bias is prevalent in finance and investing, where people often believe they understand the markets better than they do. This can lead to costly mistakes, such as buying into a stock about to crash.
While overconfidence bias can be detrimental in many areas of life, it is important to remember that a healthy dose of confidence is also necessary for success. After all, if you don’t believe in your abilities, why should anyone else?
So how will you know if your dose of confidence is healthy or harmful? Let’s take a look at some examples.
Overcoming overconfidence bias
As with other cognitive biases, you must be aware of your overconfidence bias to overcome it.
First, be honest about your expertise and experience. Unless you are a professional investor or day trader, picking individual stocks is a losing proposition. It’s just too hard for most people to do the necessary research to invest in any single company confidently, and once you factor in trade fees and commissions, it can be expensive. Moreover, investing in individual stocks does not offer much in the way of diversification. Instead, look at index funds that track a broader market or sector. These funds provide instant diversification at a very low cost and will provide solid returns over the long term.
Also, seek to develop a healthy skepticism towards investment strategies that promise high returns with little risk. Remember: if it sounds too good to be true, it probably is.
Another great strategy is to consult with an investment advisor. They can help you make sound investment decisions based on your specific situation and help you understand the inherent risks of investing. Remember to be mindful of their fees, which can eat into your returns year after year.
Taking these steps teaches you to control your overconfidence and avoid making costly investment mistakes.
Confidence vs. overconfidence: know the difference
There’s a big difference between confidence and overconfidence. Confidence is having faith in your abilities and making decisions based on evidence and logic. Overconfidence is when your ego gets in the way, and you ignore facts that don’t support your point of view.
Here are some signs that you may be suffering from overconfidence bias:
- You believe you’re always right.
- You have a hard time admitting when you’re wrong.
- You’re not open to new ideas or different points of view.
- You’re quick to judge others.
- You’re resistant to change.
If any of these sound familiar, take a step back and reassess your beliefs. Remember, being wrong is not a weakness — it’s a strength. It means you’re open to learning and growing.
The next time you’re considering an investment, take a deep breath and ask yourself if you’re really confident in your decision, or if you’re suffering from overconfidence bias.
Final thoughts on overconfidence bias in investing
Fortunately, it’s possible to overcome your overconfidence bias when investing. Remember that information is power. So when investing, consider all available information when making big decisions. That way, you can work with what you know, leaving less room for that overconfidence bias.
Julep is not a financial institution, financial advisor, or credit repair company, and does not provide credit repair services of any kind. The information provided is for general educational and reference purposes only. The information is not intended to provide legal, tax, or financial advice. We do not propose any guarantee that the information provided will repair or improve your financial profile. Consult the services of a competent licensed professional when You need financial assistance.