The effects of overconfidence bias on investing.
Biases are the filters through which we make decisions about everything—from what movies we watch, to what we have for lunch, to what we do with our money. All thoughts are filtered this way. In fact, it's impossible to make a purely unbiased decision.
What is overconfidence bias?
Overconfidence bias is the tendency to overestimate your abilities when it comes to money matters, tricking your brain into making risky bets, disregarding data, and believing it's possible to consistently beat the market.
One possible source of overconfidence: the wealth of accessible online information, which can create the illusion of understanding.1
The problem: Thinking you're better than average may fuel risky decisions.
Overconfidence may lead you to overestimate your understanding of financial markets or specific investments and potentially expose you to higher costs from frequently buying and selling assets.
A wealth of easily accessible online information, anecdotal evidence, or simple luck in random investments may encourage you to make risky decisions.
64% of investors rate their investment knowledge highly, according to a FINRA study. Yet investors with more confidence answered fewer questions correctly on an investment knowledge quiz.4
Keep biases in check by working with a Schwab investment professional.
A Schwab investment professional can be a sounding board for your investing goals and decisions, working with you to overcome any emotional or cognitive biases you may have. We can work with you on your terms, whether it's building a one-time plan, providing ongoing support, or introducing you to new products and solutions.
4 ways to remedy overconfidence bias.
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Take emotions out of the process by setting up systems.
An investment professional can help you set objectives for buying, selling, and rebalancing your portfolio. Review and rebalance your portfolio regularly to keep your long-term allocation strategy intact, rather than trying to time the market.
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Look for opportunities to further diversify.5
Certain types of assets tend to be correlated to market corrections. Working with an investment professional, you could run scenarios with different investments and evaluate their risks and opportunities. Instead of putting all your investments in assets you think are sure things, strive to reduce volatility by diversifying with investments designed to zig when others zag.
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Have a plan for volatility.
Biases can lead to ill-informed decisions. Partner with an investment professional to make a plan, agreeing to wait a set period before acting during periods of market volatility or after receiving negative news. You can also schedule periodic portfolio reviews to check your progress compared to your long-term goals.
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Practice defensive behavioral finance.
Have an open dialogue with an investment professional to make sure you're making sound decisions that fit your long-term goals.
- Do you understand what role each holding plays in your portfolio?
- Are you holding on to investments for too long?
- Have a structure in place so you understand why, when, and how your portfolio is evolving.
Take emotions out of the process by setting up systems.
An investment professional can help you set objectives for buying, selling, and rebalancing your portfolio. Review and rebalance your portfolio regularly to keep your long-term allocation strategy intact, rather than trying to time the market.
Look for opportunities to further diversify.5
Certain types of assets tend to be correlated to market corrections. Working with an investment professional, you could run scenarios with different investments and evaluate their risks and opportunities. Instead of putting all your investments in assets you think are sure things, strive to reduce volatility by diversifying with investments designed to zig when others zag.
Have a plan for volatility.
Biases can lead to ill-informed decisions. Partner with an investment professional to make a plan, agreeing to wait a set period before acting during periods of market volatility or after receiving negative news. You can also schedule periodic portfolio reviews to check your progress compared to your long-term goals.
Practice defensive behavioral finance.
Have an open dialogue with an investment professional to make sure you're making sound decisions that fit your long-term goals.
- Do you understand what role each holding plays in your portfolio?
- Are you holding on to investments for too long?
- Have a structure in place so you understand why, when, and how your portfolio is evolving.
Put your new insights into action with either managed or self-directed solutions.
Learn even more on our behavioral finance podcast.
Choiceology®
Wharton professor Katy Milkman shares true stories involving high-stakes moments and explores the latest research to help you make better judgments and avoid costly mistakes.
