Are you a better than average driver? According to a number of survey results, a lot of drivers think they are. A Survey by PublicMind at Fairleigh Dickinson University found that 68% of the drivers polled considered themselves above average, 30% considered themselves average, and just 1% considered themselves to be below average. (1% were unsure or refused to answer.) Similar results have been found in other surveys: a survey of 1,000 drivers conducted by Financial Dynamics (FD) for Allstate found that 64% rated themselves as “excellent” or “very good”, but felt only 22% of other people their age deserved those ratings. Another survey found that 93% of American drivers thought they were above average!
Statistically speaking, that doesn’t add up. In a large sample of drivers, abilities should be spread along a range of skills, from very poor to very good with a large clump somewhere in the middle. About 50% would be above average, and 50% below.
So what’s going on here? Part of the answer may be that people are more likely to give themselves a benefit of the doubt that they wouldn’t necessarily extend to others. (When you mess up you have a reason, when someone else does they just have some excuse.) Another possibility could be big differences in the standard being used by drivers in the self-examination process to evaluate just what “better than average” means. Let’s listen in as a couple of hypothetical drivers explain their driving styles.
Here’s what Daring Devon has to say: “I always get where I’m going at least 10 minutes faster than anyone else would, and I can make the car in front of me get out of my way by tailgating and flashing my lights. I never lose my place in heavy traffic by letting someone merge in front of me, and I can zip in and out of fast moving traffic with only inches of space between cars. I can steer with my knees while texting with one hand and eating breakfast with the other. Most of the accidents I’ve been in were the other person’s fault. For these reasons, I consider myself to be an above average driver.”
Now let’s hear from Careful Chris: “I never exceed the speed limit, and I always leave early enough to arrive on time so I don’t feel rushed and stressed while I drive. I follow the alternating method to allow cars to merge into my lane in heavy traffic, and in moving traffic I allow one car length between my car and the vehicle in front of me for each 10 mph I’m going. I find a safe place to pull off the road and park before texting, speaking on the phone, or eating. I have never had an accident. For these reasons, I consider myself to be an above average driver.”
Very different drivers – identical self-assessment.
But it’s not just driving skill that is often measured with a very subjective yardstick. Experience with many investors over the years reveals that they can also have very different standards for evaluating how well they measure up to the “average” investor. Here’s how two hypothetical investors might explain what they do.
First, here’s Jumpy Jules: “I like to concentrate my money in a few exciting ideas. I want everything I own to be going up; diversification just dilutes my gains. I love buying the hot stock that’s in the news, no matter how much I have to pay for it. I hold on to stocks I’ve lost money on because I’m convinced someday they’ll come back and I’ll be vindicated (or least get back the money I’ve lost.) I can list every investment I didn’t buy that later went up, but can’t remember any of the ones that later fell. My investment horizon is the time between my last account statement and my next one. My gains demonstrate my wisdom; my losses were unforeseeable – or the result of someone else’s bad advice. For these reasons, I consider myself to be an above average investor.”
Prudent Pat takes a different approach: “I diversify to limit my exposure to different risks. Having things that move in different directions helps the overall value of my portfolio to be reasonably stable whether markets are going up or down. I use a disciplined process to buy securities based on their value and how they fit into my overall portfolio. I also use a disciplined process to limit losses in each security to a manageable amount, so it won’t be as difficult to recover from any declines when they happen. My portfolio reflects my sensitivity to potential losses in my account, as well as the return I’d like to achieve. My investment horizon is tied to the time frame of my long-term financial goals. My gains demonstrate the wisdom of limiting losses while participating in prudent investment opportunities – because ups and downs are bound to come along. For these reasons, I consider myself to be an above average investor.”
A somewhat perplexed Jumpy Jules might also add:
“I don’t understand it. Despite my skill, it seems whenever I finally decide to commit my money to a soaring stock market, it takes a dive and I end up getting out again with big losses.”
Both Daring Devon and Jumpy Jules share an attitude toward risk that can eventually lead to tragedy – either physical or financial. Overconfidence in one’s abilities is one of several traits that research in Behavioral Finance implicates as a source of irrational – and costly – investment errors. There are real risks to investing, and some of the most important ones investors face are those they impose on themselves.
Emotional responses when making investment decisions can introduce something we call Investor Risk. Examples include:
Inconsistent responses to the risk versus return tradeoff –
Greed and fear are opposite sides of the same emotional coin. The idea “buy low and sell high” is easy to understand, but too often investors do just the opposite. Market declines can cause investors to avoid buying exceptional values at low prices, and soaring prices can create manias as investors chase the latest hot idea, buying high – and often ignoring their own risk profile to do so.
Attaching too much importance to short-term results –
An investor’s feelings about what’s happening right now can lead to unrealistic expectations about, or premature disappointment with, a sound investment approach. Short-term results – whether good or bad – are more likely to be a reflection of current conditions than of the long-term merits of the strategy.
Adopting too narrow of a perspective on the investment universe – References to “the Market” are common in conversations about investments, and usually mean the Dow Jones Industrial Average or the S&P 500. Daily news reports about the movements of these indices can keep them in the forefront of investors’ attention, but there’s much more to the universe of available investment opportunities than the slice represented by the large company U.S. stocks these indices contain.
Using the wrong standard to measure progress –
The emotional fog that often comes with financial news can cause investors to lose sight of the real purpose of their investment efforts. Relative success against artificially constructed market “benchmarks” is far less important than consistently preserving and building the wealth you need to reach your personal financial goals. Market indices have suffered periodic massive declines that could be devastating to investors’ portfolios – and their hopes of someday achieving their goals.
Human nature may make it difficult for us to be perfectly rational when we think about our investments, especially with so much riding on the decisions we make. After all, many of the things we hope to achieve for ourselves and our families depend on how well we conserve and build our financial resources.
At WBI we understand the importance of using tools like diversification to address investment risks, of looking for value rather than chasing fads, and of cutting losses to conserve capital. We also understand the importance of dealing with Investor Risk, the risk we face simply by being human. We’ve spent the last 22 years building a disciplined investment process designed to take the emotion out of the decision making process. We’re clear about the standard we’ve chosen to measure our success – helping our clients get where they’re trying to go financially as safely as we can.
We would all like to be above average. Our goal is to make sure that when it comes to investing we all measure up.
