Overconfidence Effect in Investing Explained
The overconfidence effect. One of the most common biases in behavioral finance is overconfidence. This one is pretty self-explanatory and is severely damaging to portfolios. Investors tend to overestimate their own abilities. This can result in engaging in stock picking that underperforms the market for far longer than they should, taking on unnecessary risk, underestimating legitimate risks, erroneously thinking that one can consistently time the market, and illusively believing you can predict or control an inherently random situation or outcome. Confidence is useful evolutionarily and socially because it gives us courage to act and pursue goals, but unfortunately, that usually works against us in investing, as short term market movements are essentially random and unpredictable. Because of that fact, greater intelligence or skill gives you no advantage. Remember that all crystal balls are cloudy and realize that you are probably not as skilled as you think you are in choosing the correct investments. Index funds are probably the way to go for investors who are able to recognize that they succumb to overconfidence bias.
#investing #overconfidence #behavioralfinance
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