That is the famous line Jack Nicholson shouted at Tom Cruise in the film “A Few Good Men.” Evidence from the field of behavioral finance suggests investors can’t handle the truth – many delude themselves about their own skills and performance. The ability to delude oneself leads to persistent and costly investment mistakes. Consider the following.

In 1965, 50 drivers were asked to rate their skill and ability the last time they were behind the wheel. About two-thirds said they were as least as competent as usual. Many even described their most recent drive as “extra good.” What is particularly interesting about this study performed by two psychologists was that all the participants had ended their last driving trip in an ambulance. Police reports showed almost 70% of the drivers were directly responsible for their crashes, almost 60% had at least two past traffic violations, a similar number had totaled their cars, and almost 50% faced criminal charges.1

This data may seem strange in light of the unique group of participants. However, overconfidence is an all-too-human trait. The same psychologists interviewed people with clean driving records and found that over 90% believed themselves to be above average.2

Overconfidence

In a New York Times article, professors Richard Thaler and Robert Shiller noted that individual investors and money managers persist in their belief that they are endowed with more and better information than others, and they can profit by picking stocks.3 This insight helps explain why individual investors believe they can:

  • Pick stocks that will outperform the market.
  • Time the market so they’re in it when it’s rising and out of it when it’s falling.
  • Identify the few active managers who will beat their respective benchmarks.

Even when individuals think it is hard to beat the market, they are confident they themselves can be successful. Here is what noted economist Peter Bernstein had to say: “Active management is extraordinarily difficult, because there are so many knowledgeable investors and information does move so fast. The market is hard to beat. There are a lot of smart people trying to do the same thing. Nobody’s saying that it’s easy. But possible? Yes.”3 That slim possibility keeps hope alive. Overconfidence leads investors to believe they will be among the few who succeed. Consider the data from a study on individual investors.