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Personal Finance

A Costly Mistake That Many Investors Make And How To Avoid It!

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How would you rate your abilities? How would you assess your driving abilities? Are you an above average driver? Unfortunately, most people, and yes, investors tend to believe that they’re better or smarter than they are. There’s a technical term for it, and it’s called overconfidence. This overconfidence can be extremely dangerous when it comes to investing. Some investors might be convinced that there is a hot new investment and that it will produce outstanding returns. One person’s salesmanship can, unfortunately, lead to another person’s misguided confidence. This is especially true in the stock market.

According to many psychologists, overconfidence is the number one cognitive bias. Furthermore, excess faith in one’s abilities can create bias and error. For example, 93 percent of American drivers claim to be better than the median. When it comes to investing, you want to be objective as its more complicated than most people think. Even the top investors in the world lose, as consistently outperforming the market can be a daunting task.

So what is the solution to overcome this tendency and bias? The solution is to be brutally honest. Unless you have superior information or a time-tested system, it will be challenging to beat the market consistently. Another solution might be to invest in low-cost index funds, this way it will protect you from the low points. The index funds have another advantage of diversification which also adds protection against overconfidence. This method is not the only solution, but it may be one solution to combat the bias. The main purpose is to recognize that humans tend to have certain biases and to acknowledge them is the first step to succeeding not only in life but also in the stock market.

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