A recent study conducted at University of Iowa has underscored the pitfalls of overconfidence in the investing world.
Results of the study, released earlier this summer, shed light on the problems that can stem from a stubborn investing strategy. Conducted through the university’s Tippie College of Business, the study focused specifically on investors who “do their own homework” and become emotionally attached to the initial findings from their research.
Local experts noted this is far from the first study pointing out the perils of overconfidence, but they also told the Telegraph Herald that the findings speak to an important truth.
“There is a lot of emotion involved in selecting and selling a stock,” said Rick Terry, executive vice president and private wealth management director for Dubuque Bank & Trust. “Once someone selects a stock, they often don’t want to admit it is wrong and sell it.”
Studying student behavior
The University of Iowa analysis focused on students who used the Iowa Electronic Market, a futures market created for research and teaching purposes. Traders on this market can buy and sell real-money contracts based on their belief about the outcome of an election or other event.
Using this system, students bought and sold contracts based on their prediction of box-office results for four movies. Students researched the films and the movie market before making their initial stock purchases, then had the opportunity to buy and sell as further information became available about the performance of the films.
The study found that “traders did most of their buying and selling based on their own information, ignoring publicly available information.”
Terry said he was not surprised by this finding, noting that many investors believe research is only necessary on the front end of an investment.
“It is a mistake to think I have done my homework, so I can quit,” said Terry. “You’re never quite done doing your homework. It is a process, not a single decision. That is the way I read the study.”
The Silver example
Brian Ormord is an independent retirement consultant with Premier Investment Services, which is Premier Bank’s investment firm.
He said he has seen many situations in which a client developed a personal attachment to an investment.
“I had a guy once who had purchased a silver fund, bought it for $30 a share,” he said. “There came a point where he had lost nearly 50 percent on his investment but he was still fully confident it would come back.”
In the end, Ormord said, the bottom line is that investors must separate their emotional attachment from the realities of the situation.
“In this situation, the guy had lost about half of his $10,000 investment,” he said. “At a certain point, you have to change your thinking (from that one particular investment) to thinking, ‘What can I do to earn back that $5,000 over the next few years?’”
Making these decisions has become more complicated in an environment where information is abundant but not always reliable. Ormord noted that 24-hour cable networks often fail to provide the level-headed, long-term mindset needed for investing.
“From the people I know who have been on Fox Business or CNBC, the ones that get invited back are those who say ‘the tides are rising’ or ‘the sky is falling,’” Ormord said. “Those who say investors should make informed decisions, and those why say common sense stuff, don’t get invited back.”
Nancy Tengler, chief investment officer for Heartland Financial USA, said she agreed with some of the study’s findings.
But she took exception to the notion that investors frequently suffer from doing their homework.
“I think the data shows that individual investors, when they do their own homework, actually do a great job,” she said. “I am an advocate for people doing their own homework.”
She also noted that investment behavior shouldn’t be painted with too broad of a brush, noting that some cross sections of the population — namely, women — have different characteristics and tendencies when it comes to investing.
“Women live their lives and are actually hard-wired in a way that results in good investment decisions,”she said.
Regardless of gender, Terry says, investors should always operate under the belief that more information is out there.
Often, investors can turn to professionals to make sure they are noticing the buying and selling signals that truly should dictate their decisions.
“Once you fall in love with a stock and disregard further info, you are closing yourself off from the environmental changes that can happen moment by moment,” he said. “We (at Dubuque Bank & Trust) know what is important to us, and I think that is a more sound strategy than saying, for instance, ‘We love Apple and always will love Apple.’”