Signs of overconfidence are rampant in all walks of life, particularly when it comes to money.
Gary Belsky & Thomas Gilovich
In the first part of this article, we have talked about overconfidence and some studies that demonstrate its existence, raising theories from psychology. However, you may still be wondering how does all of this fit into business, finance and economics? This is what we will review in this second part.
This article arises from Behavioral Economics and to give it the rigor of Psychology, in Steering Bird, online advisers in business direction, management and finance, we have worked together with Tu Mejor Tú, metas clatas para el éxito.
How does all this affect business?
Never be afraid to fail. Failure is only a stepping stone to improvement. Never be overconfident because that will block your improvement.
First of all, you have to consider that overconfidence does have an effect on your decisions. Many of these decisions have to do with your money. As Gary Belsky and Thomas Gilovich indicate in the book “Why Smart people make big money mistakes” (2009): “Signs of overconfidence are rampant in all walks of life, particularly when it comes to money”.
Here are just a few examples of how overconfidence relates to business.
Overconfidence in Financial Markets
When people are confident they go out and buy; when they are unconfident they withdraw, and they sell. Economic his- tory is full of such cycles of confidence followed by withdrawal.
George A. Akerlof & Robert J. Shiller
Think that you are going to invest in the stock market or in any financial market. Why do you choose one investment instrument over another? Think about the probability that this investment will have a return or a loss. What has happened? Most likely, you have made the decision of where to invest because you trust that it will pay off. Also, you are most likely overestimating that probability of profit that you are relying on.
We mean the stock market, not horse racing or some casino. In theory, you shouldn’t leave this to chance, but sometimes overconfidence leads you to choose stocks based on an illogical pattern. Most investors who decide to act on their own do so thinking that they will obtain better results than an investment agency or the market average itself.
Do you think you can do better than the market? Most believe that it can. Some independent investors will be able to beat the market and obtain great benefits, but most will act with the illusion or hope of doing better than the rest and their average returns will be below the market, be they stocks, real estate, commodities, cryptocurrencies, etc.
Thus, every neophyte investor acts with overconfidence when choosing their shares, mutual funds and other investment instruments, including real estate.
Now, we have talked to you about the financial market. We close with an open question. Have you noticed that you can fall victim to overconfidence in other markets? To think about it.
Overconfidence in Management
People exaggerate their own skills. they are optimistic about their prospects and overconfident about their guesses, including which managers to pick.
Overconfidence also affects other activities of your business; some examples are found in:
- Human Resources: there are recruiters who rely too much on their instincts to select new workers, and they can fall into errors generated by stereotypes or first impressions. For this reason alone, some valuable applicants could be left out of recruitment and selection processes. Human Resources units, in charge of reviewing the technical background of applicants, may fall into the same error. Thus, by trusting a certain profile “that has worked before”, you can end up discarding the best person who is in the process.
- Marketing: You have a business idea. Sounds like a great idea to you. You launch the product or service to the market. You use resources in advertising. And in the end, you have no clients. This is very common. Among several technical factors, there is a certain excess of confidence in the capabilities of the product or service. The market is full of stories of good products failing, as well as wacky ideas that ended up being commercial success. Not only new products or new markets can see failures due to overconfidence. There may also be existing products or markets, by not adapting them to new trends or by continuing to use the marketing formula that the company has been using for years.
As you can see, the effects of overconfidence in your decisions can be observed in many areas of the management. Take a look at the rest of your organization and you may find some surprises.
But this is not all. So far, we have talked to you about generalities of overconfidence from psychology and we have presented you with some cases in which its effects are seen in the management.
Soon we will publish the third part of this article, where you will discover new examples of the effects of overconfidence in business.
We are Steering Bird, online advisers in business direction, management and finance. We specialize in business analysis, control and analysis of investment projects, results analysis, processes of budget and forecast, etc.
This article has been written in conjunction with the team of Tu Mejor Tú, Metas claras para el éxito. We invite you to visit their website, know their services, articles and to contact them if you need their help.