Overconfidence
Do you frequently make trades in your investments based on financial news headlines? Many investors overestimate their ability to “beat the market” by trading frequently, leaving them with lower returns than they would get by just buying and holding a broad set of investments. Consider whether overconfidence might be affecting your portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition.
Overcome behavioural biases to reach your investing goals.
Research shows that many people are overconfident in their own investing abilities, and this leads them to tradeTrade The process where one person or party buys an investment from another.+ read full definition in and out of different investments frequently, based on headlines from the financial press or their own ideas about the market. We might understand that, on average, most people can’t “beat the market” by trading frequently, but still feel that we’re exceptional. We might feel that, because we keep up with the news, and tend to make good decisions in other contexts, we should be able to make smart investing decisions as well.
Our overconfidence can get compounded by the way we look at new information—we tend to look at this information in a way that confirms our prior beliefs. Thus, during a bull marketBull market A strong market where stock prices rise and investor confidence grows. Often tied to economic recovery or an economic boom, as well as investor optimism.+ read full definition when investments generally perform well, we might decide that it’s our trading decisions that are getting us higher returns. And during a bear marketBear market A weak market where stock prices fall and investor confidence fades. Often happens when an economy is in recession and unemployment is high, with rising prices.+ read full definition when investments perform poorly, we’ll blame the market, and hold onto our belief that we’re still good traders.
Overconfidence affects us in other contexts as well. For example, we tend to underestimate our likelihood of becoming ill or unable to work into retirement—because we feel healthy now, we’re confident that we’ll still feel healthy in the future, even if the risk that our circumstances will change before we plan to retire are real. Our overconfidence can lead us to undersave, because it leads us to plan for the best case scenario.
The best antidote to overconfidence is to give ourselves a reality check. We know that, in the long run, very few people can “beat the market” by trading frequently, and we should avoid overestimating the likelihood that we fall into this elite group. Even professional fund managers struggle to achieve better-than-market returns despite having ready access to industry reports and sophisticated computer systems for analyzing the movements of market prices and the large quantities of disclosure that companies use to report on the condition of their business.
One approach to counteracting overconfidence (as well as confirmation bias) may be to “consider the opposite”: before making a decision, think about the possibility that your beliefs or predictions could turn out to be wrong, and whether the information you have could support that possibility. This tactic can help slow down your decision-making and give you time to spot possible mistakes.
Instead of focusing on short termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition headlines, focus on your long-term goals by tracking your investment progress, including the returns on your investments, over time. You can compare against similar investments in a benchmarkBenchmark A yardstick that you can use to measure the performance of an investment. Example: a stock market index may be a benchmark you can use to compare how well your own stocks are doing.+ read full definition indexIndex A benchmark or yardstick that lets you measure the performance of a stock market, part of a stock market or a single investment. Examples: S&P/TSX, S&P/TSX Canadian Bond Index.+ read full definition, and think about whether you have a long term interest in making a change.
Read the full report
If you’re interested in how leading practitioners and regulators around the world are using behavioural insights to address issues in capital marketsCapital markets Where people buy and sell investments.+ read full definition and improve outcomes for investors and market participants, read the Investor Office Report – Behavioural Insights: Key Concepts, Applications and Regulatory Considerations (OSCOSC See Ontario Securities Commission.+ read full definition Staff Notice 11-778).