Overcoming Overconfidence Bias

Overconfidence shows up as a common investing bias that can drag down our returns. But, merely recognizing our overconfidence can improve our results. This post describes some of the ways that overconfidence fools us and how to overcome it.

Overconfidence bias is a cognitive bias where individuals overestimate their own abilities and the accuracy of their beliefs and predictions. This can lead to poor decision-making, as we may make decisions based on our overestimated abilities, rather than actual evidence.

One of the most widely recognized studies of identifying overconfidence relates to how we rate our driving ability. When surveyed, 93% of us rate our driving ability “better than average”. Which is statistically impossible.

The same results are uncovered when we describe our investing ability. Most of us place too much confidence in our own judgment, even when presented with evidence showing the truth.

So, are you guilty of being a little too confident in your own decisions?

I’ve known some investors who became crippled by overconfidence. They find a promising investment, but instead of considering how it helps them meet their financial goals, consulting with their advisors, or investing at a level commensurate with the risk, they go “all-in”. The result of investing most of your portfolio in one stock is like putting all your eggs in one basket. The risk is way out of step with the goals you’re trying to achieve.

Consider the consequences. Although you’re feeling confidence about a decision, consider what would happen if you’re wrong. This type of reflection might help you put the risk into context. Maybe the hot stock pick you’re trading on should represent a small fraction of your investment portfolio, not your biggest holding.

Next, it’s time to play devil’s advocate with yourself. Ask yourself the tough questions, like “what sets my insight apart from all other investors?” and “do I have information or insight that is unique? Or, are other investors considering the same information that I am?” Being realistic instead of optimistic can go a long way in avoiding overconfidence.

It’s also important to keep an open mind about the possibility of being wrong. Being humble and acknowledging your weaknesses can lead to growth and improvement.

Finally, pay attention to feedback, whether it’s from your boss/customers, spouse, or friends. It can come in all forms, so keep your eyes and ears open. By taking this feedback to heart, you can continue to improve and avoid the overconfidence trap.

Here are eight ways to overcome overconfidence bias:

1. Think of the consequences: Consider the potential negative outcomes of your decisions and use this as a reality check to keep yourself grounded.
2. Act as your own devil’s advocate: Challenge your own beliefs and assumptions by asking yourself tough questions. Be realistic rather than optimistic.
3. Have an open mind: Be willing to admit your weaknesses and consider the possibility of making mistakes.
4. Reflect on your mistakes: Spend time thinking about what you could have done differently and how you can improve in the future.
5. Pay attention to feedback: Take feedback from others seriously, whether it’s from a supervisor, spouse, or friend.
6. Seek multiple perspectives: Gather opinions and perspectives from a diverse group of people, rather than relying on your own judgment.
7. Be mindful of your own limitations: Be aware of your own biases, limitations and try to take them into account when making decisions.
8. Be willing to change your mind: Be open to new information and change your beliefs or course of action if presented with evidence that contradicts your initial position.

One of the ways our family office can help you make better decisions is to coach you through your most important financial decisions, acting as your most trusted sounding board. Contact Us to learn more.