Depressed Investors Don’t Need Feedback. Everyone Else Does.
by ilene - September 14th, 2009 11:08 am
Depressed Investors Don’t Need Feedback. Everyone Else Does.
Courtesy of Tim at The Psy-Fi Blog
Although it’s easy enough to show that overconfidence is a blight on investment performance we need to be careful that we don’t blind ourselves to an important reality. Overconfidence is not simply a problem for investing, it’s an issue that applies to most of us, most of the time in most of the things that we do. It’s not something we can simply stop because we wish it so.
In fact, it turns out that there is only one group of people who are not habitually overconfident. Unfortunately these people are, instead, habitually miserable. It turns out that to invest sensibly you need to be depressed.
Overconfident or Depressed
That most people are overconfident is a finding that’s been replicated scores of times on a wide variety of tasks. However, the research showing the so-called depressive realism effect indicating that depressives are almost alone in not exhibiting overconfidence at least suggests a reason – that feeling confident about ourselves is a necessary antidote to real life and that if we saw our lives and the world we live in as the ghastly messes they truly are, we’d be unable to function properly.
Trading off our mental health and general happiness in order to improve our investing returns, however, seems a bit of a bad bargain – although, we could equally well argue that if most people properly analysed their real returns they’d probably feel pretty depressed anyway. Of course, it’s quite possible that when an overconfident investor runs into the brick wall of a real bear market the cognitive car crash this causes can lead them to develop an aversion for all types of investing activities. Anything rather than face the grim reality of life as an average stock picker.
Feedback’s the Key
Fortunately there is an alternative to taking the anti-happy pills but it does require investors to force themselves to face their decisions, something the evidence suggests that many investors are reluctant to do. The problem is that unless we analyse what we’ve actually done we won’t change our behaviour, even when it’s obviously not in our interests, until we have no choice. Which will usually be when the repo merchant knocks on the door. Alternatively we need to calibrate ourselves against our actual performance and learn
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW.