Apr 29, 2017

The Overconfidence Effect

"Richards Heuer researched the behavioral biases of CIA analysts. A key finding of his research is fascinating: 'Once an experienced analyst has the minimum information necessary to makean informed judgment, obtaining additional information generally does not improve the accuracy of his or her estimates. The additional information does, however, lead the analyst to be more confident in the judgment, to the point of overconfidence [emphasis added]' (Heuer 1999, p.52).

"In a study on this effect, Paul Slovic, in conjunction with the Oregon Research Institute, studied the impact of giving additional information to individuals handicapping a horse race. First, they gave each individual 5 important pieces of information and asked for their predictions. Then they gave them each an additional 35 pieces of information. This time when Slovic asked for their predictions, the handicappers were less accurate but twice as confident (Slovic 1973)!

"This is quite similar to the impact of additional information on investing. We know that those who gather more information feel better about their investments and trade more, and we know that those who trade more underperform more. The investor is mistaking all of the additional information they are collecting as added intelligence that will enable them to trade to their advantage. Instead, the studies bear out that the added information results in overconfidence. The overconfidence in turn results in activity in the account that is actually a waste of a bunch of time, money, effort, and stress—all to create underperformance."

- Peter Mallouk, "The Overconfidence Effect," Wealth Management Update, 7/22/2014g