Investor Overconfidence Syndrome

Phil Hendry02/09/2021

‘Investor Overconfidence Syndrome’? What’s that, you say?
We recently looked at how overconfidence in business owners could be harmful and thought that there was more we could say, particularly as we seem to see more cases of what we’ve dubbed ‘Investor Overconfidence Syndrome’ or IOS.
Disclaimer: We’re not medical experts. If left untreated, IOS can lead to a loss of earnings and general nausea.
So put down the paracetamol, pop the kettle on and pull a chair – welcome to part 2!

Do any of the following sound familiar?

  • The analyst who believes they are “too big to fail” and then posts substantial losses
  • The consumer who buys an item with “easy credit” because, after all, tomorrow’s another day and they can pay it back later on, no problem!
  •  The newbie investor – their friends all seem to be making money in the latest fad. So it makes sense to get onboard as well. Right?

If so – congratulations – you’ve just identified some examples of ‘Investor Overconfidence Syndrome‘.

Overconfidence can affect us all, no matter who we are or what stage of our financial journey we’re at. The information we get bombarded with and the time it takes us to make a decision when investing means we’re more likely to fail than prosper.

The three most common symptoms of ‘investor overconfidence syndrome’ that we tend to see more often are:

Investor Overconfidence Symptom #1 – Regret

We probably invest with our hearts more than with our heads. Perhaps you may have been gifted some old share certificates and have kept hold of them, despite their value being of little worth. Or maybe you bought company shares and held onto them when they first made a small loss, forever hoping that the market would turn in your favour.

Let’s take a look at Sir Isaac Newton. We all know that name. Came up with calculus, defined several theories in the fields of maths, astronomy and physics  – by all accounts, a textbook example of a 17th century polymath.
Despite being exceptionally clever, even he could not predict why having invested in the South Sea Bubble, he first sold his stock just as it was peaking and then bought back into it, investing a greater sum. When it inevitably burst, he lost a substantial sum of money and is alleged to have never mentioned it again, avoiding it in all conversation (1)

isaac-newton-overconfidence

“I can calculate the motion of heavenly bodies, but not the madness of people” said an overconfident Newton

Investor Overconfidence Symptom #2 – Lack of investor focus & understanding

Did a teacher ever tell you to ‘pay attention’ in school? You’re not alone.
There are numerous investing options out there for anyone who wants to start putting their savings to use. The problem is that we’re all human with a limited attention span. Instead of thinking rationally, we tend to make the easiest decision. After all, why do our own research when we have friends, family and the Internet to rely on? So before you run off and commit to an idea, stop and think for once!

overconfidence-investor-syndrome

Pay attention!

Investor Overconfidence Symptom #3 – Trend & “herd mentality” investors

Let’s say you’ve read through some company’s quarterly reports, and you think you’ve spotted a trend. Well done. I dare say a trained analyst with some fancy software has already spotted this before you, and has already made money, before you have.

Similarly with Gamespot which was in the news earlier this year; once the media first reported what was going on, its share price peaked and dived back within a week. With hindsight, anyone who got in early did well but pity those who were late to the party, having joined in at the end.

Another instance – there are numerous reasons as to why the Crash of 1929 happened but one of them is the wild market speculation that went on prior, with newbie investors getting caught up in the promise of easy money and high returns, by borrowing money to buy more and more stocks or shares.

overconfident-driver

Overconfidence meant the wheels came off in the Crash of 1929…

 

However, all is not lost. Here are FOUR actions to consider:

  • Consider the consequences your decision would result in for your dearest and nearest – you may be open to taking risk but would you take on more risks if you knew it may affect your family? You may be willing to take on risk, but what if doing so would affect your being able to have enough for a first-time deposit? What about then? Imagine where you would be and what you would be doing if your risky idea paid off. And then imagine what you would be doing if it doesn’t pay off. Ask yourself – is it worth it?
  • If you don’t understand a savings or investing concept and you also can’t explain it to someone else, then walk away from it.
  • Look at past choices. Sit down with a financial adviser, for example, and look at what you have previously invested in. Getting a fresh perspective here can help – if a long-term and low-risk strategy has paid off and then you suddenly want to invest in something new and exciting, then a second opinion can offer you clarity.
  • Set yourself some goals. These should be medium to long term (the next 3-10 years) and we’ve mentioned the benefits of setting goals previously

 

 

Citations
(1) Royal Society Publishing