One of the pitfalls of investing can be overconfidence in our abilities as investors. You might be a smart and savvy investor, but it important not to let those feelings run away with you. And it is especially important not to let overconfidence in your abilities lead you to think that whatever you decide to do with your portfolio is full-proof.
Why are You Overconfident?
The problem with overconfidence is that you might not recognize it as such. However, it can be a good idea to take a deep breath and re-evaluate how you feel about your investing abilities. Explore the reasons that you feel good about your investing prowess, and see if there might be an explanation for why you feel so good. Some common sources of investing overconfidence include:
- Market Performance: Just ahead of the 2008 financial crisis, many financial markets were doing well. If you picked a particular investment, it was probably doing well, riding the wave of general gains. But you might have felt like a genius. We like to think that our solid insight is responsible for gains, and that losses are a fluke. As a result, it can be tempting to keep throwing good money after bad, convinced that you picked a winner, even though you didn’t.
- Past Performance: Sometimes, we hold on to an investment because of past performance. It’s done well in the past, so future gains are assured. Unfortunately, this confidence can be misplaced. It is important to keep tabs on the fundamentals of the investment, and realize that a good past performance doesn’t mean that the future will be as bright. If something, fundamentally, has changed for the worse, you need to acknowledge that and move on.
- Confidence in Others: Your overconfidence might not be in yourself, but in others. Make sure you understand how your broker is getting paid; don’t have confidence that he or she will always do what’s best for you. Additionally, be wary of confidence in “hot tips” or “insider” information from people that you know (or people that they know).
Overconfidence can encourage you to make poor decisions with your investment portfolio. You might invest in something that is a bad idea, or you might cling to a loser far longer than you should. In some cases, overconfidence can lead to trading too frequently, eroding returns through fees. Additionally, feelings that you should be “beating the market” consistently because of your superior abilities can lead to frustration and emotion-driven trading when your returns turn out to be merely “average.” In fact, average isn’t so bad, and is usually adequate for most people. In the end, it is important to do your best to view your investing abilities as realistically as possible.
Be honest with yourself as you review your portfolio’s performance, and try to identify some of the factors that point to success for an investment, rather explaining it by your ability to trade effectively. Yes, you might, in fact, be a trading genius. But approaching your investment strategy with humility is likely to better benefit you in the long run, rather than assuming that you can’t fail.