Can we all be above average?
Of course not. That’s mathematically impossible. By definition, half the people surveyed for any characteristic will be above average, and half will be below average. But if you ask a group of people to rate themselves in many traits—driving, or generosity, or leadership skills—a vast majority will rate themselves above average. Supposedly, this overconfidence is a source of investing difficulties
But that’s only true for some characteristics. If you ask people to rate their artistic ability, or how beautiful they are, or the quality of their singing voice, a vast minority will say that they’re above average. It seems that we overestimate our abilities when the skill is intangible, like intelligence, and we underestimate our abilities when the results are easily seen—like drawing or musical abilities. And we’re especially likely to rate ourselves below average for these skills in a social setting where we know the other people in the group.
This does have profound investment implications. When people are convinced that their view of the world is “right,” they invest accordingly. In financial markets, we can generate an informed opinion by reviewing other research, examining company financials, and looking at price action. When the market confirms (or denies) our expectations, our confidence grows. But we’re selective in what we remember, so we become irrationally over (or under)-confident.
This can lead to market manias and bubbles—as well as crashes and depressions, where prices diverge widely from their fundamental values. Prices go up because they go up, and down because they go down. Price momentum builds on itself, until valuations reach absurd levels. (Perhaps explaining why FANG stocks are currently priced at 100 times earnings—“priced for perfection”?)
Eventually, though, reality has its revenge. The world never turns out to be as rosy or as gloomy as momentum-driven market prices predict. Value-oriented investment strategies eventually outperform, but they sometimes have to endure long periods of underperformance to get there.
John D. Rockefeller once said that good leadership consists of inspiring average people to do superior work. In the same way, good investing is finding average companies that can deliver superior performance.
Douglas R. Tengdin, CFA
Chief Investment Officer