Financial personalities – investment confidence
Investing with confidence can be a good thing, but too much investment confidence can be as damaging – if not more so – than too little. Awareness of behavioural finance biases, education and experience can help achieve a healthy balance.
IN A FEW WORDS
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5 min reading
Investing with confidence should be a good thing. Certainly, it takes confidence to invest in the first place. After all, you need to back your judgement with money that it has usually taken time and skill to earn. However, there are times when investment confidence isn’t helpful, potentially pushing you into making poor investment decisions and preventing you from learning from your mistakes.
What does investor confidence mean in practical terms?
Greg Davies, head of behavioural finance at Oxford Risk says confidence governs an investor’s level of comfort with making decisions. This differs from composure, where the investor worries about the outcome of those decisions. He adds: “We find people who are not particularly worried about the outcome of the decision, they just find the process really, really uncomfortable.”
This needs to be set against the reality that almost all humans are over-confident in many aspects of their lives. Davies points out that humans tend to think that they are far better decision-makers than the evidence would suggest: this can be seen in surveys where the majority of people judge themselves to be great drivers or to have a better than average sense of humour. He adds: “There are indications this might be useful from an evolutionary point of view. If we were all perfectly calibrated, we might never get out of bed in the morning. A little bit of over-confidence is our friend.”
However, for successful stock market investing, it helps if confidence is finely calibrated. Like Goldilocks, investors should be looking for a not too hot and not too cold approach to confidence.
A lack of inexperience or knowledge means many people have low investment confidence
This is particularly true for women – confidence has the biggest gender gap of any of the major behavioural finance traits. For the most part, this lack of confidence manifests as a reluctance to do any kind of stock market investing. This can be a significant problem, meaning people’s savings don’t grow fast enough to meet their investment goals and may not keep pace with inflation. It is certainly a contributor to the gender investment gap and can make a meaningful difference to long-term wealth.
For this type of investor, says Davies, the focus needs to be on finding good ways to get them into the market without spooking them. This means finding strategies to manage market volatility are important, as they may be inclined to exit the market at the first sign of trouble, particularly if they are ‘low composure’ as well.
For low confidence investors, regular savings can help mitigate some of the highs and lows of markets, while focusing on the long-term can ensure they’re not distracted by short-term noise. A well-diversified multi-asset fund is usually a good option that doesn’t require a lot of complex decision-making on the part of the investor.
However, once this group has committed to stock market investment, they are generally more successful at it. They don’t tend to trade in and out, aren’t as vulnerable to backing the latest trendy sector and tend to incur fewer transaction costs. As Davies says: “These investors make fewer, silly over-confident marginal decisions where they think they’re right and haven’t got a clue.”
Higher confidence must be carefully managed to avoid problems for the investor
Davies says: “With higher confidence people, getting them into the market isn’t the problem. It’s trying to stop them doing stupid things when they’re there. That can be a real issue and we can start to hit problems such as confirmation bias. It is very easy for us as humans to think the thing we believe in is right and ignore the evidence that we’re wrong. We should all be trying to form a judgement based on the evidence in front of us, but this doesn’t always happen and it is a particular problem for high confidence investor types. The chances of checking their opinions and having some humility are that much lower.”
With that in mind, being smart is no protection against these behavioural biases and may actually contribute to them. Davies adds: “In fact, if you’re smart, the more likely you are to be able to construct a complex view on why you’re right rather than looking at the evidence objectively.”
Over confidence means that investors make investments without doing their research. It may also affect the way investors interpret their decisions after the event. They may remember their winners and overlook their losers. It means they don’t learn from their mistakes, which is a sure-fire way to repeat them.
Are you over-confident or under-confident in investing?
Understanding whether they are over-confident or under-confident and how this influences their decision-making can help investors.
Equally, says Davies, it is possible to change confidence levels through investing experience and education. For the over-confident, it may be the harsh reality of backing what proves to be a dud. For the under-confident, it may be the realisation that stock markets are not the great big casinos they can appear from the outside, but rather a good place to grow their money over the longer-term.
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