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Sometimes the worst day for your ego is the best day for your soul.

Michael Bernard Beckwith

Overconfidence can lead to illusions of control that can lead to biased judgments.

Ask anyone if they are an above-average or below–average driver and most will say they are above-average. Other research overestimates of leadership ability, athleticism, and competence. One study of stock analysts revealed the following: If analysts forecast that a stock will increase in value with 80% confidence, they are right about 40% of the time. With investor behavior, this overconfidence can lead to illusions of control that can lead to biased judgments, investing too much in investments about which they know too little, taking undue risks, and failure to realize they are at an informational disadvantage to institutional investors. During strong bull markets, it is easy for investors to credit themselves for their strong performance and ignore the contribution of the bull market itself to that strong performance.

If investors are overconfident about the returns they expect to get, they may save and invest less than they otherwise would.

Successful investing decisions can become a source of pride and ego gratification, and the modern-day equivalent of a successful hunter during the caveman days. A consequence of this can be not meeting financial goals. If investors are overconfident about the returns they expect to get, they may save and invest less than they otherwise would. Then if those expected returns are not realized, they could very well come up short of achieving those goals. This is particularly relevant as baby boomers are approaching retirement.

Overconfidence can also mask errors investors make.

So instead of learning from their errors, investors attribute poor investment results not to their own mistakes, but to some other cause over which they have no control. For example, with the meltdown of technology stocks in the 2000–2002 period, some investors blamed their losses on poor recommendations from brokerage firms or a “bad market”.

Another aspect of overconfidence is “optimistic bias.”

That is the tendency for an investor to be convinced that he or she will do better than other investors. However, investing is a zero–sum game in that for every seller there is a buyer, so if one made the correct decision the other did not. Overconfidence is often manifested in overtrading by investors, and especially by male investors.

Individuals who traded the most had the worst performance.

A 1998 study by Brad Barber and Terrance Odean, which analyzed the trading histories of 60,000 investors over a six-year period ending in 1996, revealed that the individuals beat the value-weighted market index by 60 basis points (1% = 100 basis points), gross of trading costs. However, trading costs were 240 basis points, resulting in underperformance compared to the index. Furthermore, individuals who traded the most had the worst performance, underperforming the index by 500 basis points.

In general, there is no correlation between overly confidence and better financial performance.

Even many financial professionals become overconfident and end up underperforming the market, as was seen with the performance of many mutual funds. At WitsMo, we believe that understanding your own money values, and biases are the key to creating a sound and personalized financial plan.

Next. Read about Money Behavioral Mistakes #1.Loss Aversion.

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