Most Investors Think They Are Above Average. The Math Says Most Cannot Be
4 min read
Loading...
4 min read
Ask 100 drivers if they are better than the average driver. In one study, 93% of the US drivers said yes about their skill.
That cannot be right. At most half of any group can sit above the middle.
The same thing happens with money. This is overconfidence bias: trusting your own skill, knowledge or forecasts more than the facts support. This post shows where the idea comes from, what a famous study found about overconfident traders, and one simple check you can run on your own portfolio.
Overconfidence bias means you believe you are better at something than you really are.
In investing it shows up in a few ways:
Confidence is not the problem. Confidence that is bigger than your track record is.
The classic example is about driving. In 1981 the psychologist Ola Svenson asked people to rate their own driving skill and safety. A majority said they were more skilful and less risky than the average driver. (Svenson, Acta Psychologica, 1981, via the TRID database; I read the summary, not the full paper.)
A 2023 replication repeated the test. Among the 81 US participants, 93% rated their driving skill above average and 88% rated their safety above average. (Replication of Svenson 1981, Meta-Psychology, via a search summary.)
One small note on the math. The "average" can be pulled up by a few very good or very bad people. So in theory more than half could beat the average. But more than half cannot beat the median, the person exactly in the middle. When 93% say "above the middle", the group is fooling itself.
Why does this matter for your money? Because overconfident people tend to trade more. They believe each trade is a good one.
Brad Barber and Terrance Odean studied this. Their 2000 paper, "Trading Is Hazardous to Your Wealth", looked at 66,465 households with accounts at a large US discount broker from 1991 to 1996. (Journal of Finance abstract, via IDEAS)
Here is what they found:
| Group | Yearly return |
|---|---|
| The market | 17.9% |
| The average household | 16.4% |
| The households that traded the most | 11.4% |
The more people traded, the worse they did. The authors argue that overconfidence can explain the heavy trading and the weak results. (Figures as reported in the paper's abstract and summaries; I did not open the full paper.)
Their second paper, "Boys Will Be Boys" (2001), used gender as a rough stand-in for overconfidence. It covered over 35,000 households. Men traded about 45% more than women, and their net returns were lower. (Quarterly Journal of Economics, via IDEAS) Sources differ on the exact size of the return gap, so this post does not quote one.
This is NetWort arithmetic with made-up numbers.
Two friends each start with Rp100 juta. Both earn the same 15% a year before costs. One buys and holds. The other trades a lot and pays 1,5 percentage points of the portfolio each year in fees and spreads.
| After 10 years | Buy and hold | Trades a lot |
|---|---|---|
| Yearly return after costs | 15,0% | 13,5% |
| Value | about Rp404 juta | about Rp355 juta |
The gap is about Rp49 juta, and the busy trader did not even pick worse stocks. Costs alone did it. Our post on portfolio turnover and what it costs you explains how this adds up.
Open the NetWort Dashboard and look at your total return and your positions side by side. Ask one question: "Would a plain index fund have done better over the same period?" Your honest answer is a better guide than your confidence.