Overconfidence in your investment knowledge may lead to poor portfolio performance. A recent report from FINRA shows that 2 in 3 investors rate their investment knowledge highly and 42% are comfortable making investment decisions. Younger investors were more likely to be confident than older ones. However, investors with more confidence also answered more questions incorrectly on a FINRA investing quiz. Technology and social media can also lead to false impressions of knowledge and skill. Investors can fall prey to “confirmation bias” by seeking out evidence that confirms a previously held but potentially false belief.
Overconfidence can lead to a variety of poor investment decisions such as buying high and selling low, over-trading and investing in high-risk assets. These decisions can result in significant financial losses and underperformance compared to the market. Here are several ways to handle overconfidence to prevent unfavorable portfolio performance.
Set Realistic Goals
One way to handle overconfidence is to set realistic goals and risk tolerance levels. Investors should assess their current financial situation, including income, expenses, and liabilities, to determine how much risk they can afford to take on. Setting clear and realistic investment goals, such as a specific return or retirement savings target, can also help prevent overconfidence.
Diversify your Portfolio
You can handle overconfidence by diversifying your portfolio as well. Diversification can help reduce risk by spreading investments across different asset classes, sectors, and geographic regions. This can help reduce the impact of any one investment on the overall portfolio performance. A well-diversified portfolio can also provide a more stable return over time.
Properly educate yourself about the markets and the economy. Keeping up to date with the latest news and trends can help investors make more informed decisions. It is equally important to understand the risks and potential rewards of different types of investments. This can help you make decisions that are more in line with their risk tolerance and investment goals.
Seek out Professional Advice
Professional Financial advisors can provide a valuable perspective on the markets and the economy, as well as provide guidance on how to build a well-diversified portfolio. Their advice can also be helpful for you to set realistic goals and risk tolerance levels. However, it is important to choose an advisor that is a good fit for you and your investment goals.
Self-Control and Discipline
Practice self-control and discipline to escape from the blow of overconfidence in your decision-making. Overconfidence can lead to impulsive decisions, such as buying or selling based on emotions rather than sound analysis. Investors like you should avoid acting on impulse and instead focus on your long-term investment goals. This finally helps prevent poor portfolio performance.
Limit Exposure to Social Media
Limiting your exposure to social media and other sources of financial news and information is another way to handle overconfidence. This is because overconsumption of financial news and information can lead to a false sense of knowledge and skill, and can also contribute to confirmation bias. Be selective and critical about the sources of financial information that you consume, and to not make investment decisions based on rumors or unverified information.
Keep Records of your Investment Decisions and Performance
Keeping track of your investments, including when you bought and sold them, and why, can help you identify patterns and mistakes in your investment behavior. It can, therefore, help you see the long-term impact of your decisions, and evaluate whether your investment strategy is working or not.
Take a Break from Investing
This is another way of handling overconfidence by taking a break from investing. Sometimes, investors can become too emotionally invested in their portfolio, and this can lead to poor investment decisions. By taking a break from investing, investors can gain a fresh perspective, and come back to their portfolio with a more objective and rational mindset.