For this article, we’re going to take you back to Statistics class. Do you remember the idea of the bell curve, or the “normal distribution?” Well, the basic idea is that, on any given data set, you have a distribution shaped like a bell—with the area under the curve representing how many of the values fall within that range. For the normal distribution, there are fewer values on the low end and fewer values on the high end, with most values falling in the middle.
The most common example of a data set using the bell curve is the Intelligence Quotient. The IQ score is weighted such that 50% of the values fall on the left hand side of the curve and 50% fall on the right, with the score of 100 being in the middle. A score above 130 is considered to be bordering on genius, while a score below 70 is considered to be severely mentally deficient. 95% of the people who take the test fall within those two extremes. So, if you ask a group of people the simple question, ‘Do you think your IQ score is above or below 100?’ What do you think they will say?
Well, what would you say? If you’re like most people, you would at least believe that you are slightly above average. No one wants to sell themselves short. But, here’s the thing. By definition, everyone cannot possibly be above average. “Average” is defined by the point at which 50% of the people who take the test fall below and 50% fall above, so it is literally impossible for more than half of the participants to have “above average” scores!
In the late 1990s, psychologists began to research how overconfidence plays into our perceptions. In one study, researchers asked a group of participants to rate their sense of humor and then make a judgment about how funny certain jokes were. They then polled a selection of professional comedians to get a fairly objective measure of how funny those jokes actually were. What they found was that everyone thought they had an above average sense of humor. But, additionally, the people whose ratings of the jokes most contradicted those of the professional comedians were the ones who thought they had the best senses of humor.
So, what does all of this have to do with investing? Ask yourself this: are you an “above average investor?” Chances are, you’re going to be tempted to answer with an emphatic, “Yes!” Of course, as we’ve already discussed, it’s literally impossible for everyone to be an above average investor. But, more importantly, thinking that you are “above average” may actually lead to worse performance.
Most investors fall into the temptation of “speculating,” because they think they have better intuitions about the market than they, perhaps, really do. Don’t be one of those investors! Check your overconfidence at the door! If you need any help managing expectations, feel free to reach out to us for a complimentary consultation. We want to help you set reachable goals, and help you navigate decisions to meet those goals, which in turn may give you the kind of success that you are expecting to find.