How To Know Whether To Trust Someone's Investment Advice

August 10th, 2013

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This blog post was originally published on the blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.

Confidence: Most people tend to trust people who are sure of themselves, over those who are not so sure of themselves. But is this a mistake?

The whole problem with the world is that fools and fanatics are always so certain of themselves, but wiser men so full of doubts. - Bertrand Russell

A couple of years ago, a hedge fund manager told me that an analyst from another fund came to see him. This hedge fund manager had a fantastic track record, so the analyst wanted to work for him. They had a nice long chat, but in the end, the manager didn't hire him. Why?

It wasn't because of his intelligence, or his work ethic.

In the manager's own words, it was because he was overconfident.

Society today tells you to be confident. Business schools are especially notorious for encouraging confidence. I did my PhD at Western, which houses the Ivey business school. It's one of the most famous and expensive business schools in Canada.

I had the chance to interact with some of the students there, and I can say that many of them are very confident. They look you in the eye when they talk. And when they talk, there's no hesitation in their speech.

But I personally feel that their confidence goes a little too far. I once heard an Ivey student say that the top 3 business school in the world are Harvard, Wharton and Ivey.

Give me a break.

To be fair, it's not just Ivey students who have that reputation. Business schools around the world have that reputation. If you look on the internet, there are even articles that try to help you deal with arrogant MBAs.

I think this is by design. Business schools know that confidence is valuable. Confidence makes you look good, which helps you climb the corpoate ladder. Confidence helps you sell products. After all, you'll probably buy a used car that "absolutely won't break down", versus a car that "probably" won't break down.

However, what's good for selling and climbing up the corporate ladder, isn't good for investing.

Many researchers have studied the relationship between confidence and investment performance. The conclusions are pretty universal. Overconfident investors do poorly compared to others.

Let me bring this home. If you talk about investing with other people, some of them will have this attitude. They'll say stuff like "Stocks will definitely go up by 15% this year!", or "Tesla will go down 30% a month from now". They'll talk as if they know the future. They're not just guessing.

Watch out for these people, because they probably suck at investing.

The same goes for these "experts" on TV.

Dr. Philip Tetlock from Berkeley tracked 284 political experts over 18 years, who collectively gave 82,000 forecasts. Do you know which group of experts came out on top?

The ones who included a lot of 'but's and 'however's in their speech - in other words, the self-critical ones.

Conversely, the experts who were more sure of themselves sucked. These experts tended to use words like 'moreover', and 'furthermore', to augment their points, rather than consider different points of view.

Nowhere else is the ability to forecast correctly more important than in the investing. I invite you to watch some of these investors give interviews. Watch carefully, especially their eyes. You'll notice that their eyes dart from one corner to another, as different thoughts crowd their mind, and impede their speech in the process. Not only do these investors use a lot of 'but's and 'however's, they stutter quite often as well.

Contrast this not-so-certain composure of these legendary investors, with those who have historically forecasted very poorly, but still gets airtime due to their marketable personalities.

They have no trouble fixating their eyes on the camera. They speak with confidence and determination. They don't say a lot of 'but's.

Here's the take home message. I know that the natural human instinct is to trust whomever seems confident. But if you're wondering whether to trust someone's investment advice, be careful about taking the advice of someone who comes across as being very confident. Conversely, if someone is careful to speak the truth, and qualifies every statement with 'but's and 'however's, give him or her a little bit of credit.

You just might want to keep that person around.

This blog post was originally published on the blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.

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