Behavioral Finance: Key Concepts - Overconfidence
AAA
  1. Behavioral Finance: Introduction
  2. Behavioral Finance: Background
  3. Behavioral Finance: Anomalies
  4. Behavioral Finance: Key Concepts - Anchoring
  5. Behavioral Finance: Key Concepts - Mental Accounting
  6. Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
  7. Behavioral Finance: Key Concepts - Gambler's Fallacy
  8. Behavioral Finance: Key Concepts - Herd Behavior
  9. Behavioral Finance: Key Concepts - Overconfidence
  10. Behavioral Finance: Key Concepts - Overreaction and Availability Bias
  11. Behavioral Finance: Key Concepts - Prospect Theory
  12. Behavioral Finance: Conclusion
Behavioral Finance: Key Concepts - Overconfidence

Behavioral Finance: Key Concepts - Overconfidence

By Albert Phung

Key Concept No.6: Overconfidence
In a 2006 study entitled "Behaving Badly", researcher James Montier found that 74% of the 300 professional fund managers surveyed believed that they had delivered above-average job performance. Of the remaining 26% surveyed, the majority viewed themselves as average. Incredibly, almost 100% of the survey group believed that their job performance was average or better. Clearly, only 50% of the sample can be above average, suggesting the irrationally high level of overconfidence these fund managers exhibited.

As you can imagine, overconfidence (i.e., overestimating or exaggerating one's ability to successfully perform a particular task) is not a trait that applies only to fund managers. Consider the number of times that you've participated in a competition or contest with the attitude that you have what it takes to win - regardless of the number of competitors or the fact that there can only be one winner.

Keep in mind that there's a fine line between confidence and overconfidence. Confidence implies realistically trusting in one's abilities, while overconfidence usually implies an overly optimistic assessment of one's knowledge or control over a situation.

Overconfident Investing
In terms of investing, overconfidence can be detrimental to your stock-picking ability in the long run. In a 1998 study entitled "Volume, Volatility, Price, and Profit When All Traders Are Above Average", researcher Terrence Odean found that overconfident investors generally conduct more trades than their less-confident counterparts.

Odean found that overconfident investors/traders tend to believe they are better than others at choosing the best stocks and best times to enter/exit a position. Unfortunately, Odean also found that traders that conducted the most trades tended, on average, to receive significantly lower yields than the market. (To learn more, check out Understanding Investor Behavior.)

Avoiding Overconfidence
Keep in mind that professional fund managers, who have access to the best investment/industry reports and computational models in the business, can still struggle at achieving market-beating returns. The best fund managers know that each investment day presents a new set of challenges and that investment techniques constantly need refining. Just about every overconfident investor is only a trade away from a very humbling wake-up call.

Behavioral Finance: Key Concepts - Overreaction and Availability Bias

  1. Behavioral Finance: Introduction
  2. Behavioral Finance: Background
  3. Behavioral Finance: Anomalies
  4. Behavioral Finance: Key Concepts - Anchoring
  5. Behavioral Finance: Key Concepts - Mental Accounting
  6. Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
  7. Behavioral Finance: Key Concepts - Gambler's Fallacy
  8. Behavioral Finance: Key Concepts - Herd Behavior
  9. Behavioral Finance: Key Concepts - Overconfidence
  10. Behavioral Finance: Key Concepts - Overreaction and Availability Bias
  11. Behavioral Finance: Key Concepts - Prospect Theory
  12. Behavioral Finance: Conclusion
Behavioral Finance: Key Concepts - Overconfidence
RELATED TERMS
  1. Current Liquidity

    The total amount of cash and unaffiliated holdings compared to ...
  2. Developed To Net Premiums Earned

    The ratio of developed premiums to net premiums earned over a ...
  3. Return On Policyholder Surplus

    The ratio of an insurance company’s net income to its policyholder ...
  4. Absolute Percentage Growth

    An increase in the value of an asset or account expressed in ...
  5. Capital Loss Coverage Ratio

    The difference between an asset’s book value and the amount received ...
  6. Policyholder Surplus

    The assets of a mutual insurance company minus its liabilities. ...
  1. How do you calculate retained earnings per share?

    Research the amount of retained earnings per share compared over time to understand whether or not a company uses its profits ...
  2. How is it possible for a company to have a negative enterprise value?

    Learn about enterprise value and how value investors use it to find good companies with undervalued stocks. Negative enterprise ...
  3. Which leverage ratios are most useful for analyzing manufacturing companies?

    See which leverage ratios investors and creditors are likely to use when analyzing the debt burdens for manufacturing companies.
  4. What is the minimum amount of money that I can invest in a mutual fund?

    Learn about investing in mutual funds even with a smaller initial investment; there are many funds available to investors ...
Related Tutorials
  1. Industry Handbook
    Investing Basics

    Industry Handbook

  2. Ethical Investing Tutorial
    Fundamental Analysis

    Ethical Investing Tutorial

  3. Investing For Safety and Income Tutorial
    Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  4. Discounted Cash Flow Analysis
    Fundamental Analysis

    Discounted Cash Flow Analysis

  5. American Depositary Receipt Basics
    Economics

    American Depositary Receipt Basics

Trading Center