401(k) Investor Achilles Heel #1: Overconfidence

From time to time, all of us think we know what we are doing when clearly we do not, but it is not until we are proven wrong that we come to realize it. For me, it’s home repair. I know it’s not my strong suit, but my “man” button keeps blinding me to that fact until I am calling the repairman to fix the original problem and everything additional that I destroyed, broke, etc.

That, my friends, is humility. And humility is good for all of us. When it comes to investing, such overconfidence in our abilities can be extremely costly. In fact, the larger the balance of your 401(k), the more costly mistakes can be to you.

401(k) investors should be very careful not to allow overconfidence to creep into their mindset after last year’s remarkable rebound, which began after the market bottomed exactly one year ago today. Being a fan of Carl Richards of BehaviorGap.com, his post in the NYTimes Bucks blog section was a great explanation of how to handle overconfidence if it creeps into your investing life.

Carl Richards

When it comes to investing, however, we all have a problem.

As we become more and more confident we become willing to take on more and more risk. Why? We start seeing risky behavior as, well, less risky. But the reality is that as the level of overconfidence increases, the cost of our mistakes increase as well.

And…

But we can do something about it. We need to recognize that we’re not as smart as we think we are. In fact, the smartest investors (and frankly the smartest financial advisers) are the ones that acknowledge that they’re dumb.

So the next time you’re about to make an investment decision because you’re sure you’re right, take the time to have what I call the Overconfidence Conversation. Find a friend, spouse, partner or anyone you trust and walk them through your answers to the following questions:

1) If I make this change and I am right, what impact will it have on my life?

2) What impact will it have if I’m wrong?

Considering the consequences of being wrong might lead you to make more careful decisions and to a greater appreciation of the enormous potential costs.

Our word to the wise is when the market has as strong of a rebound as we have seen over past twelve months, it was the market that drove our accounts to the fantastic gains we experienced in our year end statements, not us as individual investors. Simply put, if you were in stocks, you were going to make a very good return. Hey, it was great after suffering through ’08 and early ’09 until a year ago today. However, keep in mind, overconfidence in your asset allocation (investment recipe) is fine if you are positive you understand it. If not, get some help to make sure…

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