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.  

You’ll Thank Me Later.


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