You may find overconfidence in others or yourself to be a trait that's harmless, perhaps charming, or even annoying. You likely find it more compelling in an adviser than prudent caution. But that attraction to certainty can cost you a lot of money, and possibly more than that.
Consider a report on a recent study from researchers at University of California, Berkeley, and Georgetown University, titled "Cheap Talk and Credibility: The Consequences of Confidence and Accuracy on Advisor Credibility and Persuasiveness."
The authors examined confidence and accuracy among advisers and found that those who were confident but inaccurate took a larger credibility hit from clients than those who had originally hedged. That's as it should be: The proof, after all, should be in the pudding, right?
But part two of the study's findings is more troubling. Researchers also found that "when feedback on adviser accuracy is unavailable or costly, confident advisers hold sway regardless of accuracy."
And, according to the report, "People also made less effort to determine the accuracy of confident advisers; interest in buying adviser performance data decreased as the adviser's confidence went up." (Or, "I don't need to taste the pudding. I'll take this person's word for it that it's great.")
In other words, advisers are often able to get away with being overconfident -- and wrong. As customers, it means we need to be more wary -- not less -- of advisers who present their suggestions with a great deal of gusto.
According to 'the Experts' ...
There are plenty of examples of overly confident experts leading followers astray.
Think back to the 1998 implosion of Long-Term Capital Management, a hedge fund run by several Nobel Prize winners. It was probably easy for its investors to have confidence in the brilliant management team, but many billions of dollars were lost. Likewise, it's often easy for folks such as the managers themselves to have great confidence in themselves, due to their experience and expertise.
More recently, in 2006, a study found that 74 percent of fund managers believed that their performance was above average -- a mathematically impossible feat. It's the same phenomenon as the vast majority of drivers thinking they're above-average drivers. (Sorry, only half of us can actually be above average.)
Why You Need to Do Your Research
There are other takeaways from this study and others that can have a bearing on how you interpret professional advice and whether or not to act on it. For example:
A classic study found that when students were asked to spell words and estimate their accuracy, those with 100 percent confidence were accurate only about 80 percent of the time, and those with a confidence level around 80 percent were correct only about half of the time.
Confirmation bias is our natural tendency to start out with a premise or belief (for example, that a stock is a good buy or a love interest is a good match) and then focus mainly on evidence supporting that view. That tendency to see only what agrees with our previously held beliefs, and ignore data that conflicts with them, can lead us to overconfidence, in investing, relationships and more.
There are various studies suggesting that women tend to be better investors, in part because they tend to be less confident than men and therefore more risk-averse. Men also trade much more frequently, which can significantly reduce profits by boosting commission costs.
Business professors Terrance Odean and Brad Barber, well known for their studies of trading behavior, have cited overconfidence as a major factor in underperformance. In an article in the American Economic Review, Odean explained that: "The more overconfident an investor, the more he trades and the lower his expected utility. ... Overconfident investors ... have unrealistic beliefs about their expected trading profits ... at the worst, overconfident investors believe they have useful information when in fact they have no information."
Clearly, it can pay off if we question our assumptions and consider the possibility that in any given endeavor, we -- and our advisers -- may not be above average. Confidence isn't always a mistake: Some experts really do have the goods, some financial advisers really are acting in your best interests, and sometimes, you really do have the inside scoop. But keep an eye out for overconfidence in yourself and others: As much as you'll want to trust it, it has the potential to hurt you.