A recent survey of American motorists by The Allstate Corporation provided further evidence of how much we are prone to overconfidence. The survey found that while nearly two-thirds of American drivers rate themselves as “excellent” or “very good” drivers, they also say that just 29 percent of their close friends and 8 percent of drivers from other states are deserving of the same rating. More men consider themselves as excellent drivers (36 percent) than women (26 percent).

The survey also found that actual driver behaviour does not gel with the glowing self ratings. 45 percent of respondents said they have driven when excessively tired, 15 percent said they have driven when under the influence and 34 percent admitted to sending a text message or email while driving. More than half said they have been involved in an accident but only a quarter of them admitted the accident was their fault.

Like motorists, investors are also prone to overconfidence. We are confident that our stock picks will provide us with above average returns. Even worse, we fool ourselves into thinking that our investment returns are better than they actually are. Michael James recently quoted one such study that found that investors overestimated their returns by 11.6 percent a year.

This article has 4 comments

  1. I’m a stock picker, not an indexer. But I’ve been noticing that as my portfolio grows and the more names I add, the closer my overall portfolio is tracking the index anyways.

    My opinion is changing to where the point is moot now in terms of performance. The only difference is fees – whether you prefer a one time commission on the transaction, or pay an annual MER. I don’t think there’s a right or wrong answer – only what’s right or wrong for yourself.

  2. It’s not just that investors may overestimate their returns, CC… the level of overestimation likely correlates highly with the investor’s own level of incompetence, as per the Dunning-Kruger effect.

    http://en.wikipedia.org/wiki/Dunning%E2%80%93Kruger_effect

  3. @Phil: A portfolio of stocks will more or less mirror the index especially in Canada where just three sectors dominate the index. I suppose one can save a little bit by holding stocks directly but 0.17% is low enough for my investing purposes.

    @Raman: Thanks to the link to the Dunning-Kruger effect. Learnt something new today. It’s interesting, especially the cross-cultural variations.

  4. Those other people are overconfident, but I’m really an above-average driver :-) Thanks for the mention.

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