Do you consider yourself to be really good at something? Maybe it’s your driving ability, a sport, or even your memorization skills. The field of behavioural insights tells us that we tend to overestimate our abilities. Overconfidence bias is a behavioural bias in which people overestimate their abilities, intellect, character, or even luck. Find out more about overconfidence bias and how it could impact your financial decision making.
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What is overconfidence bias?
Overconfidence bias takes place when someone is excessively confident in their abilities. It can occur even when there are objective measures of the limitations of peoples’ skills — they still overestimate their abilities. Overconfidence bias can also include someone overestimating their luck (i.e., gambling) and their character (i.e., ethics). This bias is centered on our innate belief that we are better than we truly are.
What does overconfidence bias look like?
Overconfidence bias is one of the most common behavioural biases. There are many examples of where you might notice it, including:
- Projects – Whether it be in school, at work, or around the house, people consistently overestimate how quickly they can complete projects. This can lead to delays and extensions (this is also known as the planning fallacy).
- Driving – Research has found that as many as 80% of drivers consider themselves to be above average in their driving abilities. But only 50% of drivers can truly be above average.
- Investing – Many investors are overconfident in their investing skills. They believe they have the skills to assemble a portfolio of stocks and other securities which will outperform everyone else’s portfolios.
Overconfidence bias can show up in many aspects of your life. Whether it be at home, at work, or on the roads, the reality is we often think we are better than we really are.
Our individual behaviours are prone to bias. That can make financial decisions challenging. Try our behavioural bias checker to understand how biases might be affecting your financial decision making.
How could overconfidence bias affect your financial decisions?
Overconfidence bias can impact your financial decision making in a few different areas:
- Beating the market – Many investors, particularly younger investors, feel that they can beat the market. But years of historical data shows that most investment professionals cannot beat the market (and it’s their full-time job).
- Budgeting challenges – When setting a monthly budget, people overestimate their ability to stick to certain limits. For example, someone who is overconfident might think they will keep to a spending limit for dining out, even though they have exceeded that limit many times in the past.
- Saving for retirement – People who feel healthy and energetic today can be overconfident about how they might feel later in life. This can prevent them from planning realistically. They underestimate the likelihood of something bad happening to them. And they do not save as much money for the future as they should.
While some level of confidence is valuable in life, being overconfident can have a negative effect on your finances. Taken together, these effects can be costly in the long run.
How can you protect yourself from overconfidence bias?
There are several useful strategies you can use to counteract the effects of overconfidence bias on your financial decisions.
- Be a contrarian – When you feel certain about something, take a pause. Whether you’re thinking about your budget or how much you can live on in retirement, take a moment to ask yourself if your assumptions, information, or thinking could be wrong.
- Give yourself a reality check – When you’re considering something new, like a big investment or retirement plan, do your homework. Look at data and information from reliable sources to help guide your decisions and keep your expectations realistic.
- Collect feedback – Before making high-stakes decisions, talk to someone you trust. It could be a family member who works in finance or a close friend. Walk them through your thinking and ask them for feedback.
These strategies can help prevent you from becoming overconfident in your financial decision-making abilities. In the long run, they can save you time and money.
Learn more about other behavioural biases which might be impacting your financial decisions in ways you may not realize.
Summary
Overconfidence bias is one of many behavioural biases which can impact your financial decisions. Here’s how it works:
- Overconfidence bias occurs when people are excessively confident in their abilities, intellect, character, or even luck.
- This bias can impact many areas of your financial decisions and have a negative effect on your budgeting, investing, and saving behaviours.
- You can counteract the effect of overconfidence bias on your financial decisions. You could play devil’s advocate, refer to data, and collect feedback before making important decisions.
