What is... | May 2, 2013

What is overconfidence?

Do you think you’re better than average? There is a good chance more than half the population will answer “yes” to this – even though the definition of averages tells us that cannot truly be the case.

 In fact, a poll of about 300 professional investors detailed below found almost all thought they were at least average at their job. It is possible that the sample happened to be a particularly successful bunch – but it is also possible that they were overconfident in their abilities.
This tendency to overestimate our abilities in certain areas of life is part of the thinking trap known as overconfidence. Although it might not sound too troubling, studies suggest overconfidence can have many implications.

My confidence is not dented
In his 2011 book Thinking, Fast and Slow, Nobel Prize recipient and psychologist Daniel Kahneman describes his early experience with overconfidence. He had to forecast the future leadership abilities of soldiers based on observation of the soldiers performing tasks. Kahneman writes that it emerged that the forecasts were not accurate – they were, in fact, “largely useless”. But despite this, he and the other assessors kept making them and “continued to feel and act as if each of our specific predictions was valid”.
Their confidence in their abilities to judge individual cases remained despite evidence that it was largely impossible to accurately make the judgement based on simple tests.

I am totally better than average
In a survey of almost 300 professional fund managers from around the globe in 2006, 74% rated themselves as above average at their job and 26% as average. Author James Montier writes that “very few, if any” respondents thought they were below average. Given that half of people will be below average, the results suggest overconfidence is at work.
Overconfidence also seems to have resistance to lessons from experience. A 2013 study from Canada found experienced analysts to be more overconfident than inexperienced ones.

Is overconfidence a problem?
Not everyone agrees that rating yourself above average is a problem. Researchers from Uruguay argue in Overconfidence? that “there is nothing at all wrong with a strict majority of people rating themselves above the median”.
In a blogpost for eZonomics, economist Chris Dillow argues overconfidence is a “two-edged sword”. Overconfident people send out “competence cues” – speaking more loudly, having expressive body language – which, Dillow writes, can be interpreted as genuine ability and perhaps lead to job promotion over “more rational and realistic rivals”.

I’ll be a millionaire by age 30
However, being realistic can be important for professional investors as well as people who do not invest in shares for a living. The Financial Services Authority in the United Kingdom made this point in a paper on financial capability and behavioural economics. It says a survey of 8,500 British teenagers found that they expect on average to be earning a salary of £31,000 at the age of 25. But in contrast, 22 to 29-year-olds were earning £17,817 on average in Great Britain when the survey was conducted.
It says overestimating future income carries the dangers of not putting enough aside now to pay for retirement or being too ready to borrow because they are over optimistic about their ability to repay.

Why do we do it?
Why are we overconfident? One explanation is that things are more complex and difficult to predict than we think.
Kahneman writes of professional investors and other professions that appear particularly prone to overconfidence: “The question is not whether these experts are well trained. It is whether their world is predictable.”
It might also be that we jump to conclusions (or draw far too strong inferences from small amounts of information).
Another trap is to look back events that have already happened and feel like they could have easily been predicted.
Being aware of overconfidence is perhaps a good first step in trying to overcome it. Try to ask challenging questions (“can it be predicted?”) and remember that a high level of confidence in abilities, future earnings or something else is not necessarily an accurate indicator.


eZonomics team
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