How overconfidence can plague investors

Confidence is a good thing - but overconfidence can lead to downfall.

A man stands in front of an electronic board displaying market data at the Tel Aviv Stock Exchange, in Tel Aviv, Israel (photo credit: REUTERS/BAZ RATNER)
A man stands in front of an electronic board displaying market data at the Tel Aviv Stock Exchange, in Tel Aviv, Israel
(photo credit: REUTERS/BAZ RATNER)
Well, I think we tried very hard not to be overconfident, because when you get overconfident, that’s when something snaps up and bites you. – Neil Armstrong
It has been a week of milestones in the Katsman home. First, our youngest son decided that he needs to have a hamster. While his oldest sister begged him not to get one, I was more worried about what this meant for me. He very confidently calmed my nerves by saying it’s no problem and will be easy for him to care for the little rodent.
Flashback five or six years as my oldest son decided to get a hamster and assured me he would care for it, and while he enjoyed it for around 15 minutes, it turned out that yours truly had to feed it and clean the cage. If not for my dear wife noticing that we hadn’t heard from the little guy in a few days, it would probably still be lying without vital signs, in its cage. Wary of a repeat situation, I made our son sign a “Taking care of pet” contract. So far so good, as he has been feeding and holding the hamster.
Speaking of my older son, this week marked his first driving lesson. His initial feedback from his instructor was that he “has a lot of confidence,” which is probably driver instructor-speak for “slow down and drive safely!”

I’m better than Warren Buffet
Overconfidence is something that can plague investors as well. It often happens after an investor makes a few successful investments, especially when the stock market is in the midst of a good run. I remember back in 1999, people would go on and on how they were great investors as they bought hi-tech stocks and watched them double in a few weeks’ time. They convinced themselves that making money was a snap.
Well, that slap in face came during the second half of March 2000 as the stock market started a very long and painful drop, which was most felt in those very same hi-tech companies that ran up.
Over the last few weeks, as markets have surged from their coronavirus-caused drop, again it’s the hi-tech sector leading the way. Now whether the move is justified or not, is a different column. What I have started to notice from certain clients and others that I speak with that investing is easy and this will continue without interruption. I have spoken with certain clients who want to abandon their very conservative nature and start chasing anything that has a tint of technology in it.

Research not good
A few years ago I quoted Tony Giordano, senior financial adviser with Vanguard, on a piece that appeared in the Journal of Economic Perspectives, titled “Overconfident investors, predictable returns, and excessive trading.” The report said, “Investors attribute strong portfolio performance and high returns to their skills, which leads to self-assurance. When the same investors experience poor performance and low returns, they attribute it to bad luck. The result: persistent overconfidence.”
It’s that persistent overconfidence that can lead to poor investment decisions. Call it greed or whatever but I’ve seen too many times where after a good year in the market, the investor loses sight of her financial goals and needs, and decides to chase after higher and higher returns. And you all know what eventually happens, and it’s not pretty.

Long term
Though he wrote this a few years ago it seems almost prophetic, considering the stock market drop and recovery in the last three months. Giordano sums it up when he says, “If strong market performance makes you headstrong with the possibility of quick returns, avoid the temptation to go after investments that will expose you to more risk than you’d feel comfortable with under ordinary circumstances. On the flip side, if poor market performance tempts you to flee to cash, consider the longer-term implications, which include missing a potential market rebound and losing future growth opportunities.”

Asset allocation
I have said it a thousand times but it bears repeating. After figuring out your goals and needs, your asset allocation is what’s important to help you achieve those said goals. Many studies have shown that the proportion of stocks, bonds and cash held in a portfolio has a greater effect on its returns and volatility than the individual investments that are chosen.
What does this mean? Stay the course that you started out with. Part of your financial plan took into account good years in the market. Take the money and say thanks. But don’t get over confident and start getting more and more aggressive and end up making costly mistakes. If you follow your asset allocation you will be able to achieve your financial goals.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.

Aaron Katsman is the author of
Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing. www.gpsinvestor.com; aaron@lighthousecapital.co.il.