What if the key to smarter investing isn’t more knowledge, but more humility?
With the barriers to investing reduced to zero (through low investment minimums, app-based trading and zero commissions), the same innovations that might help more people invest might also inspire investor overconfidence that leads to lower lifetime returns. And it turns out that our financial decisions might benefit more from a friendly chat than from expert advice alone.
According to research published in the Journal of Consumer Research, investors who make decisions with others are significantly less overconfident than lone wolves. But perhaps surprisingly, the person you should be talking to about your investments might not be a financial salesperson.
The study found that bouncing ideas off family and friends is actually more effective at reducing overconfidence than relying solely on financial salespeople. Does that mean your nephew who tried to convince you to buy NFTs a few years ago was onto something after all? Well, no. It’s a bit more nuanced than that.
It all comes down to what is described as “metaknowledge” – understanding what you don’t know. When we discuss investments with those close to us, we’re more likely to acknowledge the gaps in our knowledge. This reality check helps calibrate our confidence to match our actual expertise.
The implications are significant. Overconfident investors are more likely to engage in risky behaviours like constantly trading stocks, buying options and crypto assets, or using margin to invest. Sure, you might hit the jackpot, but the odds aren’t in your favour.
The findings of the research don’t mean you should fire your financial adviser and rely solely on family advice. But they do suggest you should look for certain qualities in your adviser if you choose to use one:
- Emotional connection: Seek an adviser who can connect with you on a personal level, not just someone with a slick sales pitch who sees you as a number on the way to meeting a sales quota.
- Encourages open dialogue: Your adviser should create an environment where you feel comfortable discussing your uncertainties and knowledge gaps.
- Emphasizes the unknown: Look for an adviser who helps you recognize what you don’t know about investments, rather than just focusing on providing solutions.
- Uses relatable language: Your adviser should explain concepts in simple, everyday terms, just like a friend would, and not steamroll you with industry jargon.
- Encourages family involvement: An adviser should help foster a collaborative approach within the household when discussing planning and investments.
For those who manage their own investments, consider these takeaways:
- Joint decision-making was found to reduce investor overconfidence. So if you take the lead on managing and executing investment decisions, that’s fine, but your partner is part of the “board of directors” of the household and should have the opportunity to have a say with an equal vote on big picture decisions.
- Embrace the unknown: When researching or talking about investments and investment strategies, focus on what you’re unsure about. It’s okay not to have all the answers.
- Seek diverse perspectives: Don’t just read or talk to people who agree with you. Engaging with different viewpoints can highlight blind spots in your thinking.
When it comes to investing, the old adage “two heads are better than one” isn’t just a cliché – it’s backed by science. This research shows that involving others in your financial decisions, can be like adding a dose of humility to your investment strategy. It’s not necessarily about finding someone who knows more than you, it’s about finding someone who can help you recognize what you don’t know.
So the next time you’re faced with a big financial decision, resist the urge to go it alone. Instead, seek out a trusted confidant who you can connect with on an emotional level and have a conversation with that explores the unknowns.
Your portfolio – and your future self – will likely thank you for embracing the power of collaborative decision-making. In the complex world of investing, it turns out a little self-doubt can go a long way.
Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.
