Investor confidence: Are you your own worst enemy?

Abstract

Are overconfident investors more apt to make risky choices, which could erode investor returns? With confidence levels that exceed knowledge levels, investors may unknowingly expose themselves to risk. This paper shows that in terms of investing, overconfidence is associated with increased optimism as well as additional risk-taking through focused investment strategies. Specifically, overconfident individuals are more likely to be overoptimistic about their individual performance as well as overall market performance; more likely to have confidence in market regulations; less likely to seek the advice of an adviser; more likely to trade on margin; more likely to trade commodities, futures, and options; and more likely to have whole life insurance. Overconfidence may help explain why investor returns are consistently lower than investment returns. These findings are particularly relevant for financial advisers, as they serve the important role of providing feedback and sharing in the decision process.