“One of the painful things about our time is that those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.”
Friend of the firm and top financial planner, Gary Vawter, CFP®, MS, sent an email out this morning that I think is particularly insightful. It has to do with the consistent tendency of people to overestimate their skills. Check this out:
Svenson (1981) surveyed 161 students in Sweden and the United States, asking them to compare their driving safety and skill to the other people in the experiment. For driving skill, 93% of the US sample and 69% of the Swedish sample put themselves in the top 50% (above the median). For safety, 88% of the US group and 77% of the Swedish sample put themselves in the top 50%.
McCormick, Walkey and Green (1986) found similar results in their study, asking 178 participants to evaluate their position on eight different dimensions relating to driving skill (examples include the “dangerous-safe” dimension and the “considerate-inconsiderate” dimension). Only a small minority rated themselves as below average (the midpoint of the dimension scale) at any point, and when all eight dimensions were considered together it was found that almost 80% of participants had evaluated themselves as being above the average driver.
Academic ability and job performance
In a survey of faculty at the University of Nebraska, 68% rated themselves in the top 25% for teaching ability.
In a similar survey, 87% of MBA students at Stanford University rated their academic performance as above the median.
Self, friends and peers
One of the first studies that found the effect of illusory superiority was carried out in 1976 by the College Board in the USA. A survey was attached to the SAT exams (taken by approximately one million students per year), asking the students to rate themselves relative to the median of the sample (rather than the average peer) on a number of vague positive characteristics. In ratings of leadership ability, 70% of the students put themselves above the median. In ability to get on well with others, 85% put themselves above the median, and 25% rated themselves in the top 1%. [emphasis Gary’s]
So we see that, as a group, we consistently overestimate their skills and abilities. This even has a name – the Dunning-Kruger effect. It’s a phenomena the stems from a cognitive bias that we have wherein the unskilled have an illusion of superiority. It also works vice-versa, in that the skilled mistakenly attribute superior understanding to others, thus believing themselves less competent than they actually are. Neat to know, but what does this have to do with financial planning?
Cognitive biases can be trouble because they can lead your decision-making astray. Let’s say you’re deciding what investment approach you’re going to use for your retirement savings. If you are one of the unfortunate people who believes themselves skilled, but are actually unskilled, then your life savings would be at risk. If your beliefs inform your actions, and your beliefs are based on bad information, there is an increased risk that your actions may be inappropriate. And inappropriate actions generally have bad consequences.
So, we should be mindful of our flaws, and aware that ignorance can seduce us into falsely believing that we’re more amazing than we think we are.