Julie Jason's Your Money: Overconfidence can be a problem when it comes to investments

By JULIE JASON November 10. 2017 6:51PM


A while ago (2003), I wrote about a stock market study based on data at the height of the internet bubble (1999).

Two behavioral economists reported on the study, drawing conclusions about how investors act. Some of the insights and lessons are timeless.

First, individual investors might react to attention-grabbing events, such as earnings releases, while institutions might be more likely to recognize the limitations of buying stocks that are in the news.

Only you can judge whether this is true for you. If it is, there are other options. No matter what you choose to do, your methodology should be something you can articulate and measure.

The goal is to make sure that the methodology successfully achieves your capital appreciation and income goals.

Second, individual investors hold on to their losers. I do notice this tendency with some individuals I've met - they want to wait until the stock reaches their purchase price.

Is that true for you? If it is, a better option is to watch trends. If the stock is underperforming its industry or sector, find out why. There may be better choices available to you.

If you step back and ask why investors might act in any of these ways, the behavioral economists suggest it might be overconfidence - that is, investors might be overconfident in their stock-picking ability and knowledge.

In fact, the economists pointed out that some professions might exhibit overconfidence, such as lawyers, physicians, engineers, investment bankers and entrepreneurs. And there might be gender differences as well, with more men exhibiting overconfidence than women (see "Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment" in the February 2001 issue of the Quarterly Journal of Economics).

What happens when overconfidence takes hold? Investors might hold riskier portfolios, trade too much and spend too many resources (time and money) on investment information. And they might be unrealistic about return expectations.

Let's focus on return expectations in today's market.

Since we are in a long bull market that started in March 2009, the overconfident individual might be taking a position now about the stock market. Let's look at two extreme positions. One overconfident investor believes the market is too high and ready to collapse. Another is convinced the market has much more room to grow.

The reality is that no one knows. Fear can drive the skeptic, and, as Sam Stovall, chief investment strategist of U.S. equity strategy at CFRA, recently pointed out in "Stock Market Retreats and Recoveries," fear also can drive the optimist: "It's been said that fear and greed are the two emotions that drive the markets. However, one could argue that fear is the dominant emotion, since investors' two greatest fears are losing money on the way down, and then missing out on the way back up."

In today's market, the answer is: If overconfidence is driving your decisions - especially if fear is the underlying emotion - now is the time to reassess.

One more point. The economists noted: "Choosing which stock to buy presents investors with a huge search problem. There are thousands of possibilities. Human beings are limited in their mental processing abilities."

No one can argue that point. Things are different today, however. What's changed since then?

Individuals now have access to computerized screens offered by brokerage firms, such as Fidelity, and retail screening software, such as that offered through the American Association of Individual Investors. That availability can help individual investors do the type of screening that only institutions could do in 1999.

Humans still have "limitations in their mental processing abilities," but screens help narrow the universe to those stocks that an individual needs to study. And study is what it's all about. Being a successful do-it-yourself investor demands research, study and a good set of rules to follow in any type of market.

Julie Jason, JD, LLM, a personal money manager at Jackson, Grant of Stamford, Conn., and award-winning author, welcomes questions and comments to readers@juliejason.com.


BusinessLifestyleEconomy

FOLLOW US
Follow us on Twitter Follow us on Facebook Follow our RSS feed
Union Leader app for Apple iPad or Android *
Click to download from Apple Apps StoreClick to download from Android Marketplace
* e-Edition subscription required