Overconfidence Bias
A couple of months ago, my brother-in-law asked me to join him and some friends in an NBA fantasy league. Outside of the Raptors playoff games in 2019, I haven’t watched any basketball games so naturally I was feeling pretty confident. After all, I played basketball for most of my youth. He told me none of the guys in the pool knew much about basketball and that the league would consist simply of picking which teams would win more and which teams would win less games than they were projected to. So I joined.
This past weekend, I decided to check out where I stood in the rankings. As it turns out, I had 4 picks that were in winning positions. I felt pretty good about my skills as a fantasy basketball manager. After patting myself on the back for a few minutes, I started to look a little closer. The 4 picks were out of 8 total, so I also had 4 picks in losing positions. Strange how I didn’t even pay attention to the losers at first. I felt like I was pretty smart for having picked 4 winners, even though I was only 50% right. Investors tend to act similarly when assessing their past decisions. This is not a recent phenomenon. In fact, as far back as 1915 a stockbroker going by the pseudonym 'Dan Guyon' did his own research to show that clients managed to lose money even while the stocks they were investing in increased by 65%. In other words, had they just bought and held the stocks they were trading, they would have been much better off. Worse still, the investors thought they’d done pretty well. This overconfidence bias can be a real detriment to all types of investors and has a real impact on their long-term goals and can even put some of those goals out of reach. We’ve seen this countless times when meeting with prospective clients, especially those that were managing their own portfolios.
When it comes to investing decisions, it’s important to have a clear plan and process in place to execute that plan. For us, that comes in the form of an IPS or Investment Policy Statement. It outlines the investor profile, asset allocation, rebalancing, expectations for the portfolio, and monitoring process. Our clients receive a copy of this IPS for reference which holds us accountable for our actions. We’re human so we’re not perfect, but this brings us a few steps closer. There goes that overconfidence again.