We all suffer from overconfidence at some level, like in our decisions about saving and investing. We do not see any risks in what we do; because we underestimate the probability of loss. When overconfidence destroys.
We think that sudden illness, unexpected injury of life, or loss of income are all events that happen to others, not us. Each private financial plan promotes emergency fund development.
The first financial goal of a household should be to have readily accessible funds that can cover all expenses for at least six months. We are overconfident about our ability to raise short-term funds.
When overconfidence destroys
We hear stories about investing success. Many want us to believe that they somehow identified high stocks ahead of others; or that they began to invest when the Sensex was a three-digit number; or that they cherry-picked IPOs that later became multi-baggers.
There is selective relaying of information. Sometimes the stories take on a different hue. They become investment theory for the masses. Youngsters spend too much; buying a house is the best way to save; nothing beats gold as an investment; there is no loss in property retirement funds should not be invested in equity; PSIS bonds won’t default; and so on.
Such are theories that overconfidence spins, that believers don’t wish to hear anything else. Our overconfidence can mar our ability to evaluate our positions. We refuse to acknowledge that the stock we bought is losing money and has to be sold. It’s hard to book a loss because we’re confident the price will recover.
We postpone the plan to save for retirement, Confident that our earnings will grow and there is enough time.
There is an interesting idea called the Dunning-Kruger effect.
There is an interesting idea called the Dunning-Kruger effect. These cognitive scientists showed that people might lack the very competence needed to estimate whether they were competent or not correctly.
Three ideas are commonly discussed with various levels of success to deal with overconfidence. First, make your saving and investment decision a team effort. If you have a peer group that deals with similar personal finance issues but is diverse in terms of thinking, you will get the benefit of dissent. Every time someone disagrees, you may be annoyed, but if you made an effort to build consensus and buy-in, you would see the fallacy in your arguments. If investing is a serious effort for you, make time for such group activity.
It brings more benefits than keeping overconfidence in check” Second, makes it a habit to plan. If you are not making your decisions in a hurry, or on impulse, you reduce the chances of acting with overconfidence. If your actions fall within the scope of a preconceived strategy, you have the benefits of that thought process. Third, make review and evaluation an annual exercise, Look for lessons to learn. Delve into what worked and what did not.