Two Types of Investors: Overconfident and Status Quo
Do you think you have the stock market figured out? Do you think you always make the best choice, and your investment-picking skills are off the charts? Are you an active trader, constantly adjusting your position in an attempt, not always successful, to optimize results?
Or do you rather not worry about your investments much. You signed up for a 401k, or perhaps bought into a mutual fund, and are confident you don’t have to manage it too closely since things will work out in the end without your interference?
Baker and Ricciardi propose that most investors can be classified as either overconfident or status quo investors. They each have particular strengths and weaknesses, and they each suffer from different biases they need to be aware of.
If the first profile sounds like you, you’re an overconfident investor. If the second description suits you better, than you’re a status quo investor. Here’s what each of these mean:
The overconfident investor
The overconfident investor boasts an inflated view of her own skills. She believes she not only has the best information, but is especially qualified to act on it.
Overconfident investors suffer from self-attribution bias, in which all of their wins are attributed to skill, and adverse results attributed to elements outside of their control.
“Research documents that overconfident behaviour is connected to excessive trading and results in poor investment returns. It can also lead to investors failing to appropriately diversify their portfolios.” — Baker and Ricciardi
The status quo investor
The status quo investor is someone who doesn’t pay close attention to her investments. It’s the investor who’s prone to accepting the situation and settling into an attitude of inertia about her investments.
These investors tend to postpone getting started on a retirement plan, and when they do, not check on it very often.
This behavior leads to suboptimal performance, since it can result in the investor holding stock for longer than she should, not cutting her losses soon enough when necessary.
To resist status quo bias, Baker and Ricciardi suggest that you “implement a disciplined investment strategy based on a portfolio approach,” diversifying your portfolio according to risk tolerance, and also adjusting it at least once a year.
The best of both worlds
Overconfident and status quo may be the most common types of investors, but to obtain better financial results, the best strategy is to try to align the best of both worlds.
Acquire some confidence to take risks and trade a bit more often, but not too often that you overtrade, and be comfortable with having some patience to let things run their course a little.
Investors are all prone to biases, which can cloud their judgement and cause them to make suboptimal choices. Being aware of those biases, as well as how you tend to behave, will help you gain more clarity on your decision-making process and minimize your mistakes to maximize gains.