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Is Your Stock Portfolio Suffering from the Dunning Kruger Effect?

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You could be suffering right now from the Dunning Kruger effect and not even know it. Worst of all, it may be affecting your stock portfolio’s performance.

If you are one of the recently arrived “Robinhood” investors and think you have cracked the market code, you may, in fact, be suffering from the Dunning Kruger effect.

The syndrome is named after Justin Kruger and David Dunning, who outlined it in their 1999 paper in the Journal of Personality and Social Psychology. The authors introduced their paper by describing the effect:

People tend to hold overly favorable views of their abilities in many social and intellectual domains. The authors suggest that this overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it. Across 4 studies, the authors found that participants scoring in the bottom quartile on tests of humor, grammar, and logic grossly overestimated their test performance and ability. Although their test scores put them in the 12th percentile, they estimated themselves to be in the 62nd. Several analyses linked this miscalibration to deficits in metacognitive skill, or the capacity to distinguish accuracy from error. Paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities.

In plain English, people think they know much more than they actually do.

New investors often seem to suffer from this effect. Perhaps that is because many people become new investors when they see the market doing very well. They don’t want to miss out, and they jump on board when there is plenty of momentum heading their way. That can make it easy to be a winner, for a while. Then things turn sour.

Rarely do people begin investing when stocks are in a bear market. No one wants to join a losing party.

But markets are cyclical. No matter where you jump in, if you stay long enough, you’ll encounter the swings inherent in them.

You need someone who has seen the swings of markets before and can help you patiently navigate them. Someone who will care about you and whom you can actually trust, unlike a preprogrammed robo-advisor.

Action Line: Don’t let the Dunning Kruger effect ruin your retirement. Find a caring investment professional who can help you during the hard times. I would love to talk with you.

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zilldjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com