If you are a parent, and have had a child achieve the milestone of getting a driver’s license, you know how expensive it is to insure teenage drivers. If you have had both a boy and girl reach this milestone you probably also noticed that it was significantly more expensive to insure the boy than the girl.
Why is that? Are the insurance companies biased against males? Of course not. They study things very carefully and the statistics clearly show that teenage boys get in more accidents than teenage girls?
What could be the cause of that? Do teenage boys have slower reaction times? Worse vision? Or inferior hand-eye coordination? Each of these hypothesis can be proven false.
So what is the cause? In a word, overconfidence. Teenage boys aren’t worse drivers than girls by any objective measurement, they are just not as good as they think they are. The boys demonstrate hubris while the girls show humility. The boys overestimate their ability while the girls have a more accurate picture of how well they drive.
Teenage girls, for the most part, recognize that driving is a serious and difficult thing to do, and that it takes a lot of careful practice to master. Teenage boys, on the other hand, think they are invincible. They see driving as fun and easy and don’t take it nearly as seriously as the girls. The result of this overconfidence is more accidents, and higher insurance premiums, for the boys.
Studies have shown that males are more likely to be overconfident than females in many areas, not just driving. In summarizing the research on overconfidence, Tony Robins, in his new book Money: Master the Game, said, “If you are a man you are guilty of [overconfidence] by biochemistry. Testosterone equals overconfidence.” Overconfidence can be a good thing when it leads you to try difficult things you might not otherwise have attempted, but it can also be a dangerous thing.
Overconfidence and Investing
Knowing the tendency of men to be overconfident behavioral psychologists Brad M. Barber, of the University of UC Davis, and Terrance Odean, of Cal Berkeley, designed a study to determine if overconfidence hurts the investment results of males. To do this they tested the investment results of over 35,000 discount brokerage accounts from February 1991 to January 1997.
The results showed that the accounts controlled by men carried out 45 percent more trades than women-controlled accounts (a sure sign of overconfidence), and earned almost a full percentage point less in returns.
Interestingly, the women-controlled accounts also suffered from overconfidence (as measured by number of trades) just not as much as the men’s accounts. Trading decreased returns in the men-controlled accounts by 2.65 percentage points a year and in the women-controlled accounts by 1.72 percentage points a year. Both genders would have been much better off making no trades at all.
The conclusion of the study is that overconfidence erodes investment returns for both men and women, but the problem is worse for men. Overconfidence is, indeed, a significant problem when it comes to investing.
In investing, as in driving, overconfidence is dangerous. Lack of knowledge can be overcome but thinking you know more than you actually know can lead to real trouble.
Keeping overconfidence in check will improve your investment results. Except for rebalancing your account you should only make trades when you know something others don’t, which for most of us will happen rarely, if ever.
Seeing something on a cable television show or reading it in a magazine or newsletter doesn’t qualify as knowing something that others don’t. By the time you see it on television or read about it any chance to profit from the information is likely already passed. Remember the wise words of Bernard Baruch: “Something that everyone knows isn’t worth knowing.”
While overconfidence is a problem, no confidence at all might be even worse. After all, if you have no confidence in your investment ability you will not invest, which is the worst possible outcome.
Indeed, lack of confidence might hurt women more than overconfidence hurts men. In the study cited above by Barber and Odean, 79 percent of the accounts they studied were opened by men and only 21 percent by women. While actual women investors performed better than men, more women didn’t play the game at all, likely relegating themselves to the inferior long-term results of safe investments like savings accounts and CDs.
The key to successful investing is to achieve the right balance between confidence and humility; to correctly recognize and acknowledge what you know and what you don’t. This concept was summarized beautifully by Jason Zweig in his book, Your Money and Your Brain, where he writes:
“…you don’t want to downsize your confidence to nothing. An investor with no confidence will never invest at all, since investing requires taking a stand on at least some of the uncertainties the future always holds. So your goal is to be as sure as possible that you don’t think you know more than you really do. How much you know is less important than how clearly you understand where the borders of your ignorance begin. It’s not even a problem to know next to nothing as long as you know you know next to nothing.”
- Stick to widely-diversified low-cost index funds unless you truly know something others don’t.
- As you expand your investment knowledge become good at recognizing the borders of your knowledge.
- Achieve a balance between too much and not enough confidence. More often than not this will require a little more humility from men and a little more confidence from women.