There are ways to prevent the bias from negatively impacting our success as investors. We bring pre-existing biases to everything we do, including investing. Behavioral scientists have been studying cognitive biases in investing for decades. Some examples of behavioral biases that affect how people invest include: mental accounting (where investors treat different batches of money differently depending upon their source); loss aversion (a tendency to prioritize avoiding losses over seeking gains); anchoring bias (overvaluing the first piece of information learned about an investment); herd behavior bias (following the crowd instead of making one’s own decisions); and self-attribution bias (crediting oneself with gains and blaming others or outside circumstances for losses).
Investing isn’t about beating others at their game.
It’s about controlling yourself at your own game.
Today we’re going to focus on self-attribution bias in investing, which is sometimes called overconfidence bias. It is the tendency to credit positive outcomes to your own character and attributing negative outcomes to external factors. Behavioral scientists tell us that the tendency of our brains to avoid recognizing our flaws is a form of self-protection. We would rather not experience the discomfort of self-criticism and the effort of self-correction.
It may seem odd to you that I am encouraging you to be critical of yourself. I am, no doubt, a big proponent of positive thinking and self-confidence. You must have confidence in your abilities to achieve your most ambitious goals. This is especially true in the world of investing. Essential to investing success is the ability to trust yourself to implement financial strategies effectively.
But while positive thinking has many proven benefits, it must be balanced with self-awareness. As human beings, we tend to form idealistic pictures of ourselves, and have to consciously temper those ideas with realistic self-assessment.
If you have tunnel visions and only see your positive attributes, there will be negative consequences. Others may find you difficult to work with if you can’t recognize your own mistakes. Also, by failing to direct criticism at yourself, you miss out on the growth opportunities that come with self-evaluation. That’s why you should always be assessing yourself objectively to determine whether you are being overconfident.
The economic danger of self-attribution bias is that it causes investors who experience a string of successes to become overconfident. When investors are overconfident, they fail to properly consider investment decisions, and consequently make poor decisions.
In some cases, self-attribution bias causes investors to become emotionally attached to a particular stock that performed extremely well when they first bought it. The emotional attachment can result in the investor holding onto the stock despite indications that it is time to sell.
Self-attribution bias also comes into play during sudden declines in the stock market. When faced with a big hit to the value of their portfolio, many investors look for someone or something outside of themselves to blame. While outside circumstances do play a role in market downturns, it is counterproductive to focus solely on elements outside of the investor’s control. It is much more constructive for the investor to look at the big picture, which includes outside factors and their own individual investment decisions. A sense of personal accountability is a necessary factor for wealth management solutions.
Even though we are psychologically programmed to experience self-attribution bias, there are ways to prevent the bias from negatively impacting our success as investors. Try the following:
- Educate yourself — having extensive knowledge of how the investment landscape behaves is essential. Being familiar with trends and risks is also important.
- Acknowledge your personal financial situation — you must keep in mind your debts, assets, family obligations and earning potential when making financial decisions.
- Critically evaluate results — when you encounter undesirable outcomes, be mature enough to study them from a balanced perspective and learn from those experiences.
- Don’t let emotions dictate decisions — recognize your emotions around investing, and then do your best to put them to the side. Emotions should not play a role in investment decisions.
- Seek advice from an experienced financial expert — a professional will bring much-needed experience, knowledge, and perspective to your portfolio.
Ultimately, it is all about your attitude and perspective. Keep your eye on the big picture and avoid being distracted by a single area. When you encounter negative events, avoid fault-finding and blaming. Instead, take the opportunity to learn new things and better yourself.