Overconfidence Games: Why to Be Wary of Advisers Who Are '100% Sure'

×
Curb Your Overenthusiasm
Alamy
You may find overconfidence in others or yourself to be a trait that's harmless, perhaps charming, or even annoying. You likely find it more compelling in an adviser than prudent caution. But that attraction to certainty can cost you a lot of money, and possibly more than that.

Consider a report on a recent study from researchers at University of California, Berkeley, and Georgetown University, titled "Cheap Talk and Credibility: The Consequences of Confidence and Accuracy on Advisor Credibility and Persuasiveness."

The authors examined confidence and accuracy among advisers and found that those who were confident but inaccurate took a larger credibility hit from clients than those who had originally hedged. That's as it should be: The proof, after all, should be in the pudding, right?

But part two of the study's findings is more troubling. Researchers also found that "when feedback on adviser accuracy is unavailable or costly, confident advisers hold sway regardless of accuracy."

And, according to the report, "People also made less effort to determine the accuracy of confident advisers; interest in buying adviser performance data decreased as the adviser's confidence went up." (Or, "I don't need to taste the pudding. I'll take this person's word for it that it's great.")

In other words, advisers are often able to get away with being overconfident -- and wrong. As customers, it means we need to be more wary -- not less -- of advisers who present their suggestions with a great deal of gusto.

According to 'the Experts' ...

There are plenty of examples of overly confident experts leading followers astray.

Think back to the 1998 implosion of Long-Term Capital Management, a hedge fund run by several Nobel Prize winners. It was probably easy for its investors to have confidence in the brilliant management team, but many billions of dollars were lost. Likewise, it's often easy for folks such as the managers themselves to have great confidence in themselves, due to their experience and expertise.

More recently, in 2006, a study found that 74 percent of fund managers believed that their performance was above average -- a mathematically impossible feat. It's the same phenomenon as the vast majority of drivers thinking they're above-average drivers. (Sorry, only half of us can actually be above average.)

Why You Need to Do Your Research

There are other takeaways from this study and others that can have a bearing on how you interpret professional advice and whether or not to act on it. For example:
  • A classic study found that when students were asked to spell words and estimate their accuracy, those with 100 percent confidence were accurate only about 80 percent of the time, and those with a confidence level around 80 percent were correct only about half of the time.
  • Confirmation bias is our natural tendency to start out with a premise or belief (for example, that a stock is a good buy or a love interest is a good match) and then focus mainly on evidence supporting that view. That tendency to see only what agrees with our previously held beliefs, and ignore data that conflicts with them, can lead us to overconfidence, in investing, relationships and more.
  • There are various studies suggesting that women tend to be better investors, in part because they tend to be less confident than men and therefore more risk-averse. Men also trade much more frequently, which can significantly reduce profits by boosting commission costs.
  • Business professors Terrance Odean and Brad Barber, well known for their studies of trading behavior, have cited overconfidence as a major factor in underperformance. In an article in the American Economic Review, Odean explained that: "The more overconfident an investor, the more he trades and the lower his expected utility. ... Overconfident investors ... have unrealistic beliefs about their expected trading profits ... at the worst, overconfident investors believe they have useful information when in fact they have no information."

Clearly, it can pay off if we question our assumptions and consider the possibility that in any given endeavor, we -- and our advisers -- may not be above average. Confidence isn't always a mistake: Some experts really do have the goods, some financial advisers really are acting in your best interests, and sometimes, you really do have the inside scoop. But keep an eye out for overconfidence in yourself and others: As much as you'll want to trust it, it has the potential to hurt you.


Increase your money and finance knowledge from home

Investor’s Toolbox

Improve your investing savvy with the right financial toolset.

View Course »

Introduction to ETFs

The basics of Exchange Traded Funds and why ETFs are hot.

View Course »

Add a Comment

*0 / 3000 Character Maximum

9 Comments

Filter by:
bobcatlew

There is value in the advising field. Not everyone is out to pillage your savings. In fact, everyone is in search of the UHNC (ultra-high net worth client). However, one needs to test a person out for himself. The only person who is at risk is the advisor here. Can't wrong the client, can't wrong the shareholder. The only person who is expendable is the advisor who actually deals with the client. That person is on the firing line and his/her immediate supervisor is the triggerman on the firing squad. Want to get out of that headlock, move up to the firing squad. This is not necessarily the way things are, but it is the case in some corporate hierarchies. You have nothing to worry about from the advisor.

June 02 2013 at 4:32 PM Report abuse rate up rate down Reply
ken

THE ADVISORS ID STAY AWAY FROM ARE ON THE AOL/HP

June 02 2013 at 3:22 PM Report abuse +2 rate up rate down Reply
1 reply to ken's comment
J. R. Gilbert

I suggest that you might try what I do with FOX - DON'T GO THERE.

June 03 2013 at 8:48 AM Report abuse rate up rate down Reply
arenadood

If Financial Advisors are so sure of their advice why are they not filthy rich and retired living in luxury?

June 02 2013 at 11:00 AM Report abuse +2 rate up rate down Reply
1 reply to arenadood's comment
J. R. Gilbert

Many of them are, and some that I know personally are in prison because of how they got there.

June 03 2013 at 8:50 AM Report abuse rate up rate down Reply
thefosz

...


A so called Financial Advisor is nothing more than a Con-Artist. They will get you to buy something that will only benefit the Advisor. Many startup companies or many companies that are going down hill...will....offer the Financial Advisor DOUBLE COMMISSION if they can get you buy their product. So the Financial Advisor will push that much harder to get you to buy.



...

May 30 2013 at 3:54 PM Report abuse +2 rate up rate down Reply
MaryLou

Stay away from any advisor--that work for WellsFargo in Salsibury - NC lost my money- my retirement savings.

May 30 2013 at 3:10 PM Report abuse +2 rate up rate down Reply
2 replies to MaryLou's comment
MaryLou

sorry- Salisbury

May 30 2013 at 3:11 PM Report abuse rate up rate down Reply
classof68gto

It is always a good idea to get a referral if possible.

June 02 2013 at 5:25 PM Report abuse rate up rate down Reply