Unlike regret minimisation, it’s easy to succumb to overconfidence because it feels good. It’s great to feel like you’re great at what you do, that you can’t make mistakes or put a foot out of line. In fact, it’s empowering. But this kind of confidence has a dark side in investing.
Overconfidence is probably the most common flaw in investors, because 1) it makes you feel great about yourself and, 2) it’s not always easily apparent. But placing too much confidence in your own abilities to read the market, manage your stocks and predict the outcome of your investments, will lead you down a very risky path.
That’s why we’ve created this three step process to avoiding overconfidence by understanding what to look for, seeking advice and understanding the dangers of succumbing to your ego.
3 Steps to Avoid Overconfidence
1. Look for It
Understand what it is and learn to recognise it. Of course, we’re all a little overconfident at times. Most of the time we don’t even realise it. That’s why it’s important to know what to look for and identify when we’re obeying our ego, rather than our logic.
Overconfidence is a form of defence, as you can see in these common excuse phrases that you might find all too familiar:
- If only this had happened, then I would have been okay. Okay, but it didn’t happen.
- I almost had it right, next time I will. Why? Why on earth will your strategy suddenly work the next time?
- It just hasn’t happened yet. Perhaps it never will?
We’ve all at least had one of these thoughts at some point during our investing careers, and they are the death of us. Because they don’t inspire logic, reason or any kind of humble research into how to improve. Instead, they assume the “I have to be right, so what’s wrong with the world?” attitude.
When you start to blame everything around you for a failure, or solely praising yourself for success, stop and check yourself.
2. Seek and Be Open to Counsel
Everyone needs and can benefit from advice and counsel. That’s ego talking that says you don’t.
Seeking advice doesn’t have to be an acknowledgement that you don’t know what you’re talking about, sometimes it’s simply a sound board for you to bounce your own ideas off and to figure them out yourself. But if you’re not open to others criticising your ideas, then that’s a clear indication that you’re probably in danger of being overconfident.
This is called anchoring, which is directly related to overconfidence. It’s when you decide on an investment choice based on the information you have, but when you get new information later on that affects your choice, you then simply revise your old analysis instead of starting from the beginning. You’re so anchored in your initial thoughts, that you don’t fully embrace the new information nor have it truly reflect in your analysis.
3. Understand the Dangers
The easiest way to avoid overconfidence is to understand how dangerous it is to your portfolio. No one wants to put their investments in unnecessary risk, and so when you can fully understand that is where overconfidence places you, it’s easy to try and avoid it.
So what is the risk? Well, it’s not pretty. Overconfidence takes form in a blatant disregard for actual statistics due to a false sense of bravado in your investment knowledge, which may or may not be good, but eventually leads to immense losses because of your refusal to learn and move forward.
A quick solution: Overconfident investors are usually under-diversified, as your confidence in a stock will often drive the majority of your investment into it, and this means that they are more susceptible to a volatile market. So, if you’re worried that you are overconfident and are struggling to remedy this, diversify your portfolio to protect yourself against the dangers of overconfident investing.
The simplest method to avoiding overconfidence would be to take your ego out of the situation and subscribe to a smart stock picking and portfolio management tool, which will guide your investment choices and aid you in making decisions to buy, hold or sell based on financial data and fact.