Most investors are overconfident to a fault. Don't believe me? Consider the following anecdote: A man was terrified to fly, yet thought nothing of roaring down the street -- sans helmet, no less -- on his Harley. That reveals a high degree of confidence in his own skills vs. a highly trained pilot's. That's some risk-analysis engine you got there, bub.
That blind faith in our own abilities may have come in handy on mammoth hunts, but it is hardly beneficial when to comes to picking stocks. And that's before we even get to the "flight or fight" response. Our natural instinct during periods of volatility is to stop the pain, not to endure it with patience. The natural reactions to discomfort or threat -- coupled with a natural inability to be patient -- doesn't serve us well in the market. During market bottoms, most of the herd is selling. To buy during periods of intense selling means leaving the safety of the crowd, standing out, risking humiliation.
We simply were not designed for that.
Why Not Just Index?This overconfidence leads to the optimistic yet misguided belief that most of us can beat the market. We must believe we can outperform the major indices. Otherwise, the rational thing to do would be to simply buy a major index and forget about it.
A few recent studies support those conclusions. One in USA Today found that most people are no good at investing, and another in The New York Times revealed that people have a poor grasp of basic economics.Most investors -- the 80% who underperform -- would probably be better off going the index route. If you're still interested in trying to outperform -- despite all we discussed today -- then I admire your gumption. Over the coming months, we will share some tools to do just that. Next week, we take a closer look at the competition. (Be afraid ... be very afraid.)
|1.||Expect to Be Wrong||2.||Your Fault, Reader|
|3.||The Wrong Crowd||4.||Bull or Bear? Neither|
|Check back for more of Barry Ritholtz's
Apprenticed Investor series