Consumer Confidence Survey. Source: St. Louis Fed
It’s an important question. Studies published over the years demonstrate that most people overestimate their abilities and their potential for reaching their goals. Julie Andrews illustrated this 60 years ago in the movie “The Sound of Music” when she sings “I have confidence.” The song makes an ironic point: her character’s confidence was wildly misplaced. She had very little reason to expect everything to “turn out fine” given the challenge she was facing and her lack of experience.
It’s easy to see people’s overconfident today. When speakers ask a gathering to indicate if they think their driving is above average, about 90% of people raise their hands. Of course, it’s mathematically impossible for 90% of all drivers to be above average. We don’t live in Lake Wobegon, where all the children are above average.
Our overconfidence can hurt our financial prospects. Most people under-save and over-consume, figuring everything will turn out fine. Some people over-trade their investment portfolios, chasing hot ideas and suffering when these fail to live up to the hype. But more common is intense inactivity. An analysis of 1.2 million 401(k) investors revealed that over 80% of investors did nothing over the study’s two-year period, and an additional 11% made only one transaction.
At a minimum, people should review and rebalance their portfolios every few years, especially when their life-circumstances change: marriage, having kids, approaching retirement, and so on. There’s nothing to save us from our own financial mistakes. The most common result of our overconfidence is making no decision at all.
Douglas R. Tengdin, CFA