In the overconfidence bias investors tend to hold under-diversified portfolios because they underestimate the downside while overestimating the upside. They may also trade excessively, leading to high costs and underperformance. Because they are prone to remembering only their better investments, investors should keep detailed records of trades, including the motivation for each trade. By doing so, the investor develops a track record of investment performance relative to strategy. Both successes and losses should be analyzed relative to the strategy used to generate them to determine when strategy produced the results and when luck (market forces) produced the results. Overconfidence does lead to too narrow of a confidence interval for predicted forecasts but simply increasing the confidence interval is not as effective at reducing overconfidence as keeping detailed records of trades and reviewing those records. Seeking the opinions of others to find contrary viewpoints allowing for further scrutiny of predictions is something the CFA curriculum suggests analysts do to reduce overconfidence in their forecasts. |
