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The Psychology of Overconfidence; Why your finance adviser’s OVERCONFIDENCE is Dangerous to YOU! March 15, 2010

Posted by shaferfinancial in Finance, Uncategorized.
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The psychology of overconfidence is well studied.  It’s genesis is in feelings of superiority.  Now these feelings can be generated by actual facts [you really could be better than everyone else at something] or it could be generated by ego [you feel you are smarter than others so why wouldn’t you be able to outperform others?] or it could be history [you always have done better than others at a particular item].  The bottom line is that overconfidence leads to a failure to take into account how reality is not conforming to the expectations you have.  Malcolm Gladwell wrote a great article about this here.

In other words, you are not analyzing the facts as they become apparent, but are relying on your expectations as to what will happen.  And when those expectations veer off from the facts, you do not react and make the appropriate changes.

In the personal finance world, that is where we are with most advisers.  Most of these folks, for various reasons, think they know what is going to happen with their investment/savings strategies.  And when the unfolding facts don’t adhere to those expectations, they were unable to make the changes necessary.  Take, for example, the strategies to invest in mutual funds inside a 401K/IRA/Roth wrapper.  Almost all financial advisers can do the math to see how damaging large losses are.   Yet, how many suggested that their clients be prepared to sell their funds, in the face of economic events that would create huge losses in those accounts?  No, they were overconfident in the beliefs about how the market was going to go forward.   They were overconfident in their beliefs that market timing doesn’t work [even though there is ample proof that certain types of market timing does work], because in their previous experience during the 18 year bull market and even the 8 years after the end of it, simple buy-and-holding mutual funds worked pretty well.  The crack in that wall [including the dollar-cost-averaging scam] began to appear in 2000 and each year after there was further evidence amassing.

But, that is ancient history now.  But, what is not is that these very same advisers, who should be wary of those strategies now, still remain steadfast to the mutual fund industry and its propaganda.  And even more perplexing is that people who should be just as wary, those that suffered dramatic losses in their accounts, haven’t made any changes in their strategies.  No, they are starting to put their money back into the mutual funds.

The financial world is different now than it was from 1980 to 2000.  You need to adapt to this new reality.



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