Why your ‘ego’ investment could be costing you big money

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When it comes to investing, you may know less than you think – and overconfidence could be costly.

Almost 2 in 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 aged 18 to 34 were more likely to be confident than those in older age groups (35 to 54 years old and those over 55).

However, investors with more confidence also answered disproportionately more questions on a financial questionnaire – suggesting that “many younger investors are not just uninformed, but may be wrong,” according to the report

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Why your ‘ego’ investment could be costly

This is not to say that confidence is a bad thing. But “overconfidence bias”—the behavioral principle of overestimating one’s financial ability—can have damaging results.

“It should come as no surprise to the average investor that overconfidence can be a path to poor portfolio performance,” wrote Omar Aguilar, CEO and chief investment officer at Charles Schwab Asset Management, on the topic.

For example, this “ego bias” could trick your brain into thinking it’s possible to consistently beat the stock market with risky bets, Aguilar said. (Hint: Statistics show it’s hard for the pros, so it’s probably hard for the average person, too.)

In addition to potentially adding unnecessary risk to a portfolio, overconfidence could introduce higher relative costs associated with buying and selling assets frequently, Aguilar said.

Social media contributes to overconfidence

Understanding how confident you should or shouldn’t be is called “calibration”. People are generally well-informed if they receive frequent feedback on decisions, telling them whether they were right or wrong in direction, said Dan Egan, vice president of behavioral finance and investing at Better .

The problem is that people often don’t get that feedback in financial situations, Egan said.

“It’s very easy to get the impression that, ‘Actually, I know a lot and I haven’t been proven wrong,'” Egan said. “And we’re not going to find him. “

“We tend to protect our egos,” he said. “We want to think well of ourselves.”

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Technology and social media have also made it easier for people to develop false ideas about their own knowledge and skill, Egan said. For example, investors can fall prey to “confirmation bias,” where they look for evidence in social media circles that confirms a previously held (but potentially false) belief about an investment. .

Of course, technology and the Internet have also made it easier than ever to access information – although users then need to find out if that data source is accurate and reliable.

And while younger investors may overestimate their experience, it’s not clear how much it hurts them, Egan said. They may not have accumulated much money so early in their careers, meaning that a mistake could be less costly compared to older people, who have built up a large nest egg over their working lives and have more to lose

When investment is fashionable, ‘start looking at yourself’

Overconfidence tends to show up more often with get-rich-quick investment decisions, Egan said.

“That’s when you have to start looking at yourself,” he said.

Take the meme-stock bonanza or the cryptocurrency rush in 2021, for example. Millions of investors created brokerage accounts early in the year largely to take advantage of rising prices; if they got in or sold at the wrong time, it could cost them a lot of money.

Similarly, overconfidence could cause hasty investors to accidentally buy the wrong stock, Egan said.

For example, many investors bought Signal Advance stock last year after a tweet by Elon Musk, who asked fans to “use Signal,” caused the stock to rise by more than 400% in day. However, investors accidentally bought the wrong stock – the CEO of Tesla and SpaceX was referring to the encrypted messaging app Signal, but Signal Advance is a small manufacturer of parts.

How to check your investment ego

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One way to overcome overconfidence is to study past investment decisions and how they worked out, Aguilar said. Examine how overconfidence may have led to negative outcomes over time and what could have been achieved with a more rational approach, he said.

In addition, investors can use a “pre-mortem” strategy, Aguilar said.

The concept – coined by psychologist Gary Klein and endorsed by proponents such as economist and Nobel laureate Daniel Kahneman – seeks to overcome overconfidence by imagining outcomes that could be from a future perspective. The purpose is to improve judgment rather than be “autopsed” after death, Klein wrote.

Imagine – maybe one, five, 10 or 20 years from now – that your investment was successful. Think about the reasons for that success. Also, think it was a disaster and think about the reasons, said Aguilar. The exercise may help people see “dangers and missteps” that they overlooked because of too much optimism, Aguilar said.

“It’s worth being aware of the error, I think, without a doubt,” Kahneman said of the strategy.

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