How to stop being overconfident with your money



Growing up, if a group of our friends formed a cricket team and were asked the question “Who wants to lead?” », The 11 hands would go up. We firmly believe that we are perfect employees, perfect citizens, perfect parents, perfect spouses, perfect drivers and, of course, perfect investors. But how can someone be perfect in all aspects? Welcome to a deadly emotional prejudice that has led to the downfall of great empires, companies, artists, and investment portfolios – overconfidence.

The “experts” risk turning into astrologers. Like Rolf Dobelli, the author of The art of thinking clearly, writes, we comment on stock forecasts, the direction of interest rates or corporate earnings in the next one to three years with a healthy dose of overconfidence. We systematically overestimate our ability to predict, and the scope of our knowledge, on a massive scale. Often the experts fall prey to overconfidence more than the layman.

Know what you don’t know: “Overconfidence bias” is a tendency to have a false and misleading assessment of one’s skills, intellect or talent. It comes from an illusion of knowledge. Highly skilled teams involved in solid research studies sometimes create an illusion of superiority and control over outwitting the market.

“I try to get rid of people who always confidently answer questions they have no real knowledge of. To me, they are like the bee dancing its incoherent dance. They just screw up the hive, ”said Charlie Munger, vice president of Berkshire Hathaway.

Lucky results can also lead to overconfidence. With a few consecutive wins, the player begins to believe that he is led to favorable results due to his skills. Complacency also makes us overconfident.

Many invest when past returns have been high, not realizing that at this point it is the risk that is high, not the potential return. Good investors look for the reasons for outperforming or high performance, understand the investment framework, consider whether the cycle will turn, and then make an investment decision.

Respect the variables: Investors appreciate strong advice from “experts” that the Nifty will cross 25,000; or that 10-year bond yields will reach 9%. Some will not only forward these messages to friends, but also invest money on the basis of such overconfidence. , track how past predictions, made with “confidence”, have underperformed. Investing and economics are not like mathematics or physics, which are areas of exact science that work according to a definite formula. As you invest, there are many moving parts and non-stationary data. The research results in partial, sometimes imperfect, information.

How to resist the temptation to trust too much money: First of all, let’s recognize that being a good engineer, or a doctor, a lawyer or a data scientist, or a teacher does not guarantee us a ticket to be among the best investors. Start with this recognition and work with a good expert to help you with your investment decisions.

I keep repeating this advice seeking contribution because investing is serious business and good advice can go a long way in reducing our behavioral mistakes and training us to become better investors over time. Second, while forging yourself a confident vision for the future, also assess what can go wrong if the vision does not come true. What can be the downside?

Doubt of extreme views and exaggerated returns: For example, when the return on equity of Indian companies varies from 10 to 20% from one cycle to the next and you are promised returns of 20 to 25% based on the last three years only, be skeptical. . When interest rates are on average 8% in India and you expect to gain 10% in bond funds just because they were 12% last year, it gives rise to doubts. Good advisers and wise fund managers can never be overconfident. They are more often in doubt, constantly thinking about what can go wrong as much as what will work well. They will always have answers within a range with probabilities of various good and bad returns. They will prepare you for some pain, rather than pushing you to invest on the basis of guaranteed results.

If you have designed an investment vision based on a hypothesis, think about the opposite vision. This will help you to have a balanced outlook for decision making and avoid losses due to one-sided and overconfident view.

Finally, learn from history. Learn more about what went wrong in investing and why. Be objective, rational, evidence-based. Become an above average investor by being less confident.

Kalpen Parekh is President, DSP Investment Managers.

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