Under or overconfidence: Striking the right balance as an investor
Written and accurate as at: Oct 14, 2024 Current Stats & Facts
By Simon Russell
Overconfidence has different components, but perhaps the simplest way of describing it is the feeling that we’re better at something than we actually are. The archetypal example here is the better-than-average driver effect: when you ask people to rate their driving ability, around 80% will consider themselves above average.
Of course, we know that’s a statistical improbability, but it describes a common human tendency, and this can be especially problematic when it comes to investing.
We spoke to Simon Russell, Founder and Director of Behavioural Finance Australia, about some of the telltale signs of overconfidence in an investor and how it might lead us astray.
The signs of overconfidence in an investor
Taking on too much risk
Overestimating your abilities can lead you to take on much more risk than might be sensible. That might mean investing too heavily in speculative assets, such as mineral explorer stocks, new tech startups or cryptocurrency. These aren’t necessarily bad investments — occasionally they are spectacularly successful — but if they make up the bulk of your portfolio then it might be an indication that you’re underestimating the risks.
Trading too much
Having an overconfident belief that you can anticipate the market might also lead to too much trading. If you think you know the precise valuation of a company, you might be more prone to buying its shares when you think they’re too low and selling when you think they’re too high, for example. But timing the market can be extremely difficult, and if you’re trading excessively it can increase the likelihood you’ll incur trading costs and capital gains tax as well.
Too much DIY
Maybe you think that investing isn’t all that complicated, or perhaps you had some early successes that led you to believe you can go it alone. Whatever the reason, insisting on doing everything yourself might not necessarily be the right move. Whether you have a self-managed super fund or an investment portfolio, input from professionals of some kind — such as financial advisers or accountants — can be helpful.
The signs of underconfidence in an investor
The risks of overconfidence might be plain to see, but there are downsides to underconfidence too. Here are a few of the signs that you might be lacking in confidence and what it might mean for your investments.
Taking too little risk
Volatility is an inescapable feature of the share market, but for many people it can be hard to stomach. Where a lack of confidence becomes a problem is when it leads us to make hasty decisions that don’t necessarily suit our needs — like switching our super from a high growth investment option to a low growth, low volatility option in response to a declining share market.
If the market is falling and the stress of seeing your super go down is going to impact your life, then that might warrant sticking with the conservative option. But if retirement is still decades away and you’re comfortable ignoring your balance while the market goes through its usual ups and downs, then you’ll probably be better served keeping your super in a high growth option; it will most likely mean that you’ll have more super to spend in retirement
Inability or unwillingness to make active choices
A lack of confidence might also be preventing you from making relatively simple decisions, such as putting more into super beyond what your employer is already contributing. The same goes for adjusting your level of insurance — if the default insurance option through your super isn’t suitable, then you might be exposing your family to financial hardship in the case of your death or disability. As with many things, a little bit of education about the benefits can help boost your confidence. And in many cases, you won't need to save any extra money — all you need to do is make a choice.
