Personal Finance Essentials
Overconfidence Bias
The Psychology of Investing > Overconfidence Bias
This is when you overestimate your knowledge, abilities or the accuracy of your predictions.
We tend to think we’re better than we actually are. We do this because we want to feel in control, as that helps us feel safe. We not only tend to recall our successes more than our failures – we also tend to attribute our successes to skill and our failures to bad luck.
The Trading Study
One study analyzed more than 150,000 accounts at a major discount brokerage firm. The researcher found that women earned 1.5% more per year in the stock market than men, and single women earned nearly 2.5% more per year than single men. The difference wasn’t stock-picking skill – both groups were equally poor at selecting individual securities. The difference was trading frequency: men traded 45% more than women. The more you trade, the more transaction costs you incur and the more opportunities you create to buy and sell at the wrong time. Overconfidence in your ability to time the market is what drives excessive trading – and it destroys returns.