Are You Overconfident?

One of the personality traits that gets in the way of successful investors is the overconfidence problem.  From CBS News:

Overconfidence in our abilities may, in some ways, be a healthy attribute. It makes us feel good about ourselves, creating a positive framework with which to get through life’s experiences. Unfortunately, being overconfident of our investment skills can lead to investment mistakes. Among those mistakes are:

  • Concentrating assets and failing to diversify because diversification is only for those who cannot foresee the future
  • Buying risky investments because they believe they aren’t really risky
  • Trading too much because they believe they can successfully time the market
  • Using active fund managers because they believe they can identify the few future outperformers

I saw this Yale lecture from Robert Shiller which has this great experiment that demonstrates our overconfidence.  Start the video at about the 40:00 mark OR simply ask your students to answer the questions listed below.  When answering these questions ask your students to provide a range of answers with a 90% confidence interval (in other words, provide a range of answers that would lead them to believe that they have about a 90% probability of being right).

So, for example, if the question was “How many Major League baseball teams are there?, you might guess a range of 20-40 teams.  The correct answer is 30 and since that is in your range you would be accurate.

The three questions that Schiller asks are (and be sure that your students don’t access any devices while trying to answer these questions):

  • How many people currently are alive on our planet? Answer here.  As of 3/4/15, 7.2 billion people.
  • How much does the earth weigh in billions of tons? Answer here.  5,974 billion billion tons
  • How many languages are currently spoken in the world?  As of 3/4/15, 7102 languages, according to Ethnologue.com

In his class of Yale undergrads, about 80% answered question #1 and about 10% answered question #2 and #3 accurately (accurate meaning the answer fell within the range of answers that they provided).

See how your students do…and then ask them why they were overconfident.