Overconfidence and motivated reasoning are human psychological behavior that usually leads them to think highly about their ability. In particular, overconfidence tends to make people believe that their knowledge and judgment are accurate, mainly leading them to make poor decisions (Qasim, et al., 2019). In most cases, overconfident people seem to have biases in information processing which ultimately causes judgment error. Overconfidence in most occasions goes hand in hand with motivated reasoning (Qasim, et al., 2019). Motivated reasoning refers to an ideology that people form in their mind that makes them perceive themselves better than other (Stone, et al., 2018). In other words, people will always tend to maintain a positive image about themselves hence making decisions that will have a favorable outcome depending on their perception. Ideally, motivated thinking is the driving force that fuels overconfidence in individuals.
Under many circumstances, displaying overconfidence usually leads to making poor decisions that may be costly to their investment. Decision-making is a process that people have to deal with on a daily basis regardless of their position in society or the workplace (Qasim, et al., 2019). One of the most challenging decisions that many people struggle with daily is waking up once the alarm clock rings. Basically, one can choose to turn off the alarm clock and continue sleeping or wake up and start their daily schedule. In this case, people will decide to wake up since they need to maintain their lifestyles (Stone, et al., 2018). However, there are decisions in life that require time and deliberation before concluding. For instance, when it comes to investment matters, a person must evaluate the outcome before settling for a particular course (Qasim, et al., 2019). Nevertheless, people who tend to be overconfident seem to make a high judgmental error because they believe they have enough information concerning the matter, affecting their outcome.
This paper will focus on evaluating two studies carried out to determine the effect of overconfidence on investment decisions. The paper shall first analyze a research paper published by Annals of Education titled, Overconfidence Bias and Investment Decision. In this research document, the authors demonstrated the effect of overconfidence bias on investment decisions (Noreen, et al., 2016). The authors open up their arguments by stating that people have developed that investment has always incorporated rational decisions. Ideally, this statement is quite logical since it would be hard to imagine that people would place their money on an investment that bears little or no returns while they can opt to invest in better business (Noreen, et al., 2016). According to their findings, the authors state that this is not always the case since there is a group of investors who tend to portray an overconfident behavior in their investment decisions.
The report continues to express that the notion of overconfidence comes from optimism, confirmation, and illusion of control biases. In other words, this group of investors believes that they have what it takes to make the best decision. As a result, the overconfident investor will make excessive trading since they are optimistic that they have the knowledge required to make the right decision (Noreen, et al., 2016). In most cases, this kind of investor ends up making wrong predictions that affect their outcome. According to the research, in most cases, the overconfident investor usually gets low returns for their investment since they did not take time to study the market (Noreen, et al., 2016). On the other hand, the less overconfident investors take time to study the market before investing their money. In other words, they are cautious, an attribute that helps them make minimal judgmental errors hence maximizing their returns.
In the second research, called a study of existence of overconfidence biases among investors and its impact on investment decision published by ELK Asia Pacific Journals, the findings were more-less the same. The paper stated that overconfidence is a behavior trait that many investors seem to possess (Trehan et al., 2011). Most overconfident investors seem to portray similar characteristics, including the illusion of control, optimism, trading experience, and trading frequency. These traits lead the investors to make investment under-informed predictions since they believe they are smart and have the knowledge needed to make sound investment decisions (Noreen, et al., 2016). However, the study’s authors illustrate that the display of overconfidence is the primary cause of making investment error that ruins the investor’s portfolio (Trehan et al., 2011). Additionally, the study also states that men are more likely to display overconfident behavior compared to women (Trehan et al., 2011). This illustration means that men will conduct excessive trading than women putting the men at the risk of losing returns on investments. In other words, women make more rational decisions making them better investors.
Based on the study, the overconfidence behavior displayed by this group of investors is a psychological fact known as bias that is present in humans. The bias effect may appear consciously or subconsciously, making people make irrational decisions. According to the paper, overconfidence usually leads to illogical interpretation and inaccurate judgment in a replicable pattern (Trehan et al., 2011). In other words, people who tend to make irrational judgments are likely to repeat the same mistake. People who make bad investment decisions will always feel obligated to make another trading trying to cover up for the losses they might have incurred. Consequently, this makes the overconfident investors make a series of irrational decisions, thereby affecting their business reputation (Trehan et al., 2011). The study also found out that male investors with higher knowledge in finance are more prone to overconfidence since they perceive themselves as more informed.
The two studies seem to draw the same conclusion that indicates a relevant correlation between overconfidence and poor investment decision-making. Consequently, it is evident from the two researchers that people who portray overconfident behaviors tend to have excessive trading without considering the environment surrounding the market at the time of their investment (Noreen, et al., 2016). It is also clear that the two papers have established that overconfidence is a significant contributor to irrational decisions that lead to low returns on investments. The two studies have also applied the use of questioner methodology in their research (Trehan et al., 2011). The questioner in both studies aims at finding the investment behavior of the selected participants. However, the first study’s participants include finance graduate and finance postgraduate students from Muhammad Ali Jinnah University Islamabad. On the other hand, the second study’s participants include active investors in the financial market.
Additionally, the two studies hope to establish the level of confidence displayed by the participant. Ideally, the results derived from the questioners will later act as the precursor that will determine how their confidence levels affect their investment decision. From the first study, it is evident that the environment that envelops the market at the time of investment matters to the people with low overconfidence levels (Noreen, et al., 2016). The opposite is the case of those who display a high overconfidence level (Qasim, et al., 2019). They believe that they have enough knowledge to determine the perfect investment and do not have to rely on the circumstances prevailing at the moment. The second study displayed the same conclusion indicating that rational investors had better outcomes on their returns (Trehan et al., 2011). At the same time, their overconfident counterparts believed that they had the ability to control their portfolio. Essentially, the two papers develop the same notion that overconfidence is a significant factor that affects the investment decision-making process.
Based on the two studies, it is clear that overconfidence is an element that leads to poor decision-making. Ideally, people who perceive themselves as knowledgeable and well-informed will always overlook factors necessary for making rational decisions (Qasim, et al., 2019). For instance, while making an investment decision, it is appropriate to study the market and factors that may affect the trade, including bad news. Based on the two studies, rational investors will consider how the news is likely to influence the market before deciding to invest. This concept helps them make informed decisions hence maximizing their returns on investment (Trehan et al., 2011). Basically, the idea does not only apply to the investors but to various activities that people conduct on a daily basis. For instance, a student who bears the overconfident characteristic is likely to write a wrong answer during an examination because they do not take their time to study the question extensively. Therefore, people need to think things through before making decisions regardless of their experience.
The two reports have created an avenue for future researchers concerning the subject. The first study indicates that since the participants drawn for the study were finance students, it would be appropriate to use real investors in the future (Noreen, et al., 2016). Apparently, the researchers believe the students may have been cautious during the research process since they are aware of the risks involved in making irrational decisions (Noreen, et al., 2016). For these reasons, they would have corresponded in a different manner if they were in actual practice. Additionally, the students may not be familiar with the real challenges that affect the investors hence limiting the report’s results. On the other hand, the second research indicated that future research could cover the relationship between demographics and overconfidence (Trehan et al., 2011). Since the research took place in the Indian stock market, the results may not apply to an investor in the United States (US) market. In other words, people from different cultures portray different characteristics, which mean that they may display varied results.
In conclusion, based on the two studies, it is apparent that overconfidence is a trait that negatively affects people. Although, in some instances, a person may display overconfidence unconsciously, it is essential to act cautiously to avoid making decisions that may affect the outcome of their activities, most especially for people dealing with aspects that might directly affect other people (Qasim, et al., 2019). For instance, it would be fatal for a doctor to display overconfidence when treating a patient. Doctors should be alert at all times and ensure that they follow the prescribed procedure while handling patients to avoid irrational decisions that may cost the patient’s life. The same case applies to every other professional since it is important to act ethically while conducting official duties (Qasim, et al., 2019). After several years in practice, it is always tempting for a person to assume that they have enough experience running their affairs. Nevertheless, it is more profitable to ensure that one considers all factors before making the final decision.
References
Noreen, M. & Asif, M. (2016). Overconfidence Bias and Investment Decision. Annals of Education journal
Qasim, M., Hussain, R., Mehboob, I., & Arshad, M. (2019). Impact of herding behavior and overconfidence bias on investors’ decision-making in Pakistan. Accounting, 5(2), 81-90.
Stone, D. F., & Wood, D. H. (2018). Cognitive dissonance, motivated reasoning, and confirmation bias: applications in industrial organization. In Handbook of Behavioral Industrial Organization. Edward Elgar Publishing.
Trehan, B., & Sinha, A. K. (2011). A study of existence of overconfidence biases among investors and its impact on investment decision. Asia Pacific Journal, 11, 1-15.
