Confidence is Great, Right? Nope, It’ll Wreck Your Life

by Darwin on January 24, 2012

We’re all taught to be confident from childhood.  You know, those confidence boosters like getting a trophy no matter where you placed, parents telling you that you can do anything in life and so on.  On some level, having confidence in yourself and what you can achieve does allow you to think big, stretch your limits and achieve great things.  On the other hand, over-confidence is the single biggest predictor of disastrous results and people seldom hold themselves accountable for their bias toward overestimating themselves.  Not sold?  You will be soon:

Here are a few common examples demonstrating how people are overconfident in their abilities and the disastrous results that ensue.

Test Scores:  Rather than provide you with all anecdotes, I’ll include some studies and sources as well.  When it comes to students, time and time again, studies have shown that students tend to believe they scored or placed much higher on a grade or comparative basis than they actually did.  Why?  They’re overconfident in their performance and abilities.  (Study and another Study).  What are the implications?  Well, we all know how important academic achievement and performance is to financial success later in life.  The implication is that students will often tend to procrastinate, slack, underestimate the effort and requirements to prepare for assignments and exams, and ultimately, not realize their potential.

The Financial Collapse:  This is perhaps the most important and impactful evidence of overconfidence in recent history.  More than anything…bad regulations, bad bankers, bad loans or lying on mortgage applications, the single biggest cause of the EXTENT and damage done by the financial crisis was OVERCONFIDENCE.  The biggest banks in the world hired the smartest kids from top technical and math programs like MIT and Harvard.  These quants were to redefine financial innovation.  They were brilliant.  They were so smart that they figured out how to combine and repackage risky mortgages into AAA debt instruments and sell them to clients, while managing their risk with CDOs.  They were so confident in their models that nobody bothered to challenge them…or ridiculously, even notice that the spreadsheet cell for home price appreciation only had the ability to enter a positive number.  Seriously, some models didn’t allow for an entry to show a decline in real estate prices.  Brilliant.  Anyway, this overconfidence in having these really smart quants that “figured it all out”, and then executives who continued to be overconfident in their firm’s risk management and cash positions ultimately led to the worst crash most of us have ever seen.

Fights: Most guys (and some feisty gals) can relate to this.  We all think we can kick pretty much anyone’s ass, especially when you’re a teenager.  You know, some kid’s being a jerk, one thing leads to another and next thing you know, you’re on the ground looking up with someone laughing, saying “he just got knocked the F&*# out hahaha”.  So, if 95% of guys think they can win a fight, but obviously, only 50% actually WILL win a one on one fight, there is a huge asymmetry there.  Lots of kids (myself included) end up with a trip to the ER or worse because they were overconfident in their abilities to best their opponent when they should have just walked away.  Aside from all the ancillary reasons why getting in fist fights is detrimental to your finances, your reputation and your health, the sheer statistics should make you think twice… but we don’t.  We’re overconfident.
Your Own Personal Finances:  I’ll tell it to you straight.  Most of you are overconfident in your financial future.  I’ve been.  Here are 6 common financial miscalculations you should assess.  On top of that, many of us (myself included) used leverage to buy into a crashing housing market and over-estimate how our investment returns will fare (and also foolishly believe investment newsletters will “beat the market”).  Chances are, when accounting for inflation and a lousy job market, your income in the future will not be what you think, your investment returns will be worse than you think, and you will incur expenses that you couldn’t have imagined in your wildest dreams.  Overconfidence will cost you dearly.

Drunk Driving:  Why do people drink and drive?  A large part of it is overconfidence.  You think a) you’re not really drunk, b) you won’t get caught, and c) your driving will not at all be influenced by the delayed reaction that alcohol causes.  You’re a great driver after all, better than most other drivers.  You’re only driving 5 miles home.  And next thing you know, you’re in the police station.  I’ve had a few friends nailed for drunk driving.  Thankfully none of them killed anyone.  But it was quite costly.  Loss of license, thousands of dollars in legal fees and insurance increases.  All for what?  Overconfidence.

What Is the Takeaway?  

Stop Being So Damned Confident!  
Be Scared.  
Be Conservative in Your Assessments.  
Be REALISTIC.  

You’ll Thank Me Later.

Thoughts?

{ 21 comments… read them below or add one }

Money Beagle January 25, 2012 at 10:27 am

I agree with most of these. I was always pretty conservative when estimating my grades so I would more often than not get a better grade than what I had thought after taking a test. On pure multiple choice exams, I would actually ‘grade’ myself before turning it in, giving myself 1 point for every question I was really confident on, 0.5 points on questions I was sure but a little hesitant, and 0 points for every one I just guessed at. I’d usually come close to my actual grade but would often score a few points higher.

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Darwin January 26, 2012 at 11:29 pm

I see this at work too with peers and reports. People always tend to think they fared better than, well, how everyone else views them.

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retirebyforty January 25, 2012 at 1:31 pm

Drunk driving is a big problem. People gets over confident when they are buzzed. One or two beers won’t stop me from driving either. I know that’s bad so that’s why I try to take public transportation as much as possible when I go out. I’m pretty sure I’m over the legal limit with one strong pint.

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Darwin January 26, 2012 at 11:29 pm

I’m usually the designated driver; my wife likes her margaritas LOL.

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Invest It Wisely January 28, 2012 at 7:59 pm

Yeah this is the sort of overconfidence I actually had in my earlier 20s that was quite dangerous. I never drove drunk or close to it, but the things I did while sober were bad enough. I don’t know what it is about getting behind a wheel that changes personalities. ;)

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MoneyCone January 25, 2012 at 1:37 pm

The price Steve Jobs had to pay for his overconfidence was terrible. I’m talking about the Jobs before his second coming!

But learn he did from his failures and came back stronger than before. Cautious confidence is good. Over-confidence results in failure.

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Darwin January 26, 2012 at 11:30 pm

Oh yeah; I did a whole post on how his “faith” killed him. http://www.darwinsmoney.com/when-faith-kills/

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Jeff @ Sustainable Life Blog January 25, 2012 at 4:44 pm

nice post – i’d have to agree with this. I think the confidence is most stirring and disasterous when people look at the numbers (in the case of their finances) and see that they are broke and in a shitty situation and still believe they are fine.
I guess that’s the case for fights too – if you wind up with a broken jaw and 3 black eyes, and still think you’re good at fighting you’ve got a problem – results speak for themselves.

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Darwin January 26, 2012 at 11:31 pm

I guess part of that is denial as well. I’ll have to write a post on financial denial as well!

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krantcents January 25, 2012 at 4:50 pm

Confidence is good until you become overconfident. I constantly reflect on my decisions and adjust my effort. Confidence come from years of accomplishments. Can you be overconfident or miss something? Absolutely!

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Darwin January 26, 2012 at 11:32 pm

I’ve been guilty… like my investing prowess in my early years. I tended to selectively remember my wins and gloss over the bad investments.

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OnAHumanJourney January 26, 2012 at 12:21 am

Great points made here! Thanks for a good read Darwin.

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Darwin January 26, 2012 at 11:32 pm

I’m glad you enjoyed; thanks for visiting!

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101 Centavos January 26, 2012 at 9:21 am

Cautious in some situations, risk-taking in others. While you could say that only the paranoid survive, it ain’t bragging if you can do it (sorry for indulging in platitudes, I’m running a little dry this morning).

I was a serious slacker at times in college. I figured I could just whiz through it at the last minute. Which I did, but it cost me many all-nighters and not as high a grade as I could have gotten.

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Darwin January 26, 2012 at 11:33 pm

I was a big proponent of the 80/20 rule. B+s were good enough for me. It turned out OK, but in today’s hyper-competitive economy and job market, I think I’ll push my kids a bit harder. B+ students may have trouble getting jobs in 10 years…

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Invest It Wisely January 28, 2012 at 7:58 pm

I did the same thing in college, but shaped up in uni! My “study” habits from K-12 to college were completely atrocious, however.

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Little House January 27, 2012 at 11:00 am

I definitely would have to agree with all of these. Over confidence allows people to slack off and make silly mistakes whether it’s on a test or with their finances. I think the one area that I don’t feel over confident, however, is in my finances. I know I’m not an financially savvy as I should be.

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Invest It Wisely January 28, 2012 at 7:55 pm

I like that you decided to look at this from the other perspective! I never had that much confidence except when I was very young, like younger than 7. Then I had WAY too much overconfidence and I’m lucky that I didn’t accidentally kill myself with the stuff that I did, haha.

Regardless of why I lost that overconfidence, I think there are both pros and cons to being under confident. The con is obviously being more afraid to take risks and go for things, and that is something that really held me back in my mid-teens to early 20s and still affects me sometimes today, but there is a pro, too. The pro is that because of that feeling of inadequacy, I am pushed to work harder and go further, because I am not confident that I have gone far enough. Even though I don’t have that wonderful feeling of being on top, it sure has helped push me to go much further than anyone ever expected back from those HS days!

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John | Married (with Debt) January 28, 2012 at 8:31 pm

Reminds me of my favorite cognitive bias, the Dunning-Kruger Effect, which theorizes that some people are overconfident in their abilities, and are actually too ignorant to even know how wrong they are. Conversely, those who actually possess more knowledge are underconfident, and likely to defer to those with confidence.

Great post.

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Wayne @ Young Family Finance January 30, 2012 at 1:43 am

Be Realistic.

I think, when it comes to investing for retirement, the enemy of realistic is time. The further retirement is, the more unrealistic people’s expectations are for their investments. Sobering your expectations in the early years is essential.

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MyMoneyDesign February 8, 2012 at 11:26 pm

Great perspectives! I agree. You need to approach every situation with skepticism. You need to ask questions. In order to know that you’re right, you first have to ask how you might be wrong.

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