Are You Good at Poker?

How about investing?

Just about everyone knows that three of a kind beats a pair, even those of us who don’t play poker.  But as I point out in an example for my college class, it takes a higher level of skill to play and consistently win at poker than merely knowing the relative values of the hands.

Where many people fool themselves is in their estimation of their skills.

Suppose two people take a test, and it takes a lot of competence to receive a good score.  And suppose that the outcome is that one person earns a good score while the other does not.

When asked to estimate their test scores, who do you think will underestimate their performance – the competent or the incompetent individual?

Competent people will underestimate their scores — and, unfortunately, incompetent individuals will consistently overestimate theirs.  That’s what two psychologists from Cornell University showed in an article brought to my attention by Robert Folsom of Elliott Wave International entitled, Unskilled and Unaware of It: How Difficulties in Recognizing One’s Own Incompetence Lead to Inflated Self-Assessments.

These psychologists tested competence in four broad categories where “knowledge, wisdom, or savvy was crucial.”  The less competent a person was, the more he or she tended “to grossly overestimate their skills and abilities.”  In contrast, even the highest-scoring individuals underestimated themselves.

This study was done in an academic setting with non-financial topics, yet I couldn’t help but think about how it applies to the average investor.  The only thing worse than making a bad decision is to make a bad decision and think it’s good: “Unskilled and Unaware of It.”

As for folks who underestimate their abilities, to my ears that sounds like humility. Acquired expertise does not come easily.  Experience usually involves a lot of failures, and nothing instills humility the way failure does.  Learning from failures might as well be the definition of how to gain “knowledge, wisdom, or savvy.”

Have we here at Hepburn Capital made our share of mistakes along the way?  Of course, we have.  Are we the wiser and more savvy for it?  Yes, absolutely — and we’ve had more than our share of successes, too.  It’s better to underestimate, and it never hurts to be over-prepared.