Think you’ve got investing skill? Your overconfidence may be costly – CNBC
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When it comes to investing, you may know less than you think — and that overconfidence may be costly.
Almost 2 out of every 3 investors rate their investment knowledge highly, and 42% are comfortable making investment decisions, according to a recent report published by the Financial Industry Regulatory Authority. Younger investors ages 18 to 34 were more likely to be confident than those in older age groups (35- to 54-year-olds and those over age 55).
However, investors with more confidence also disproportionately answered more questions incorrectly on a financial quiz — suggesting that “many younger investors are not simply uninformed, but potentially misinformed,” according to the report.
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Why your investment ‘ego’ may be costly
This isn’t to say that confidence is a bad thing. But “overconfidence bias” — the behavioral principle of overestimating one’s financial acumen — can have damaging results.
“It should be no surprise that for the average investor, overconfidence can potentially be a pathway to poor portfolio performance,” Omar Aguilar, CEO and chief investment officer at Charles Schwab Asset Management, wrote on the subject.
For example, this “ego-driven tendency” might trick your brain into thinking it’s possible to consistently beat the stock market with risky bets, Aguilar said. (Hint: Statistics show it’s tough for the pros, so it’s bound to be hard for the average person, too.)
Beyond adding potentially unnecessary risk to a portfolio, overconfidence might introduce higher relative costs associated with the frequent buying and selling of assets, Aguilar said.
Social media contributes to overconfidence
Knowing how confident you should or shouldn’t be is known as “calibration.” People are generally well-calibrated if they get frequent feedback on decisions, letting them know if they were directionally right or wrong, said Dan Egan, vice president of behavioral finance and investing at Betterment.
The problem is that people don’t often get that feedback in financial settings, Egan said.
“It’s very easy to have an impression of, ‘Actually, I know a lot and haven’t been proven wrong,'” Egan said. “And we don’t go looking for it.”
“We tend to protect our egos,” he added. “We want to think well of ourselves.”
Technology and social media have also made it easier for people to develop false impressions of their own knowledge and skill, Egan said. For example, investors …….