What is Self-Enhancement?

In behavioral finance, self-enhancement is a common emotional bias. Also referred to as the self-enhancing bias, it is the tendency for individuals to take all the credit for their successes while giving little or no credit to other individuals or external factors. People may emphasize their positive attributes while at the same time highlighting negatives associated with others. This can impact investors negatively as they become overconfident about their abilities; they will attribute past success to their own skill and reject the role of timing or other factors in those outcomes.

Understanding Self-Enhancement

People who have achieved success, in the financial markets or otherwise, have the tendency to attribute much of that success to their hard-work, skills, intelligence or creativity. Luck and other outside influences are largely discounted, lest they diminish the credit due to their own explicit abilities. When a person seeks to self-enhance, they may conveniently discount important factors. For example, investors who are self-enhancing may attribute their portfolio returns largely to their stock selection skills rather than a bull market occurring over the same period of time.

Examples of Self-Enhancement

A common example of self-enhancement is the finding that most people rate themselves "above average" when asked to rate their abilities and rate others as "below average." Most people rate themselves above average at driving a car while rating other drivers below average. Of course, by definition, it is impossible for everybody to be above average. People also tend to rate their personal attributes such as attractiveness, intelligence, leadership ability and patience as above average.

Self-enhancement can occur in many different situations and under many different guises. The general motive of self-enhancement can have many different underlying explanations, each of which becomes more or less dominant depending on the situation. In a financial context, self-enhancement can serve as something of a call-option. Whereby, an individual can selectively exercise the call-option to attribute self-enhancing outcomes to their own design while letting the option expire under scenarios one wouldn't want to take credit for.

The Dangers of Self-Enhancement for Investors

As mentioned, self-enhancement leads to overconfidence and overconfidence of any sort puts investors at a disadvantage in the market. Investors can quickly go from discounting information that diminishes their ability to discounting market data that goes against their investment thesis. It is also important for investors to improve on how they make decisions.

If investors attribute all the losses to the fickle market and the gains to their skills, then they will never improve their understanding of how the market actually works and how to profit within it.