How superiority bias hurts you financially

  • Business
  • Saturday, 29 Oct 2016

IT’S EASY for most people to accept that they do not belong to the top 1% or 5% in many fields – income, intelligence, health, strength, beauty, humour. We can be realistic – to a degree. But it is very hard for people to accept that they do not belong to the top 50%. 

In fact, if you ask people whether they belong to the top 50% of the population in any of these fields – driving skills, job performance, honesty, memory – 90% of people will say they do, which obviously doesn’t make sense. Voila: the superiority bias illustrated. 

The superiority bias is sometimes called the “Lake Wobegon effect”, after a fictional town from writer Garrison Keillor, where “all the children are above average”. 

It basically comes down to having an inflated view of ourselves; to believe we are much better in comparison to the general population than we actually are.  We are optimistic about ourselves and realistic about others. 

While this is harmless in many ways, when it comes to managing your finances and investing, it can be extremely dangerous. 

Let's take a look at two examples: buying real estate and investing in the stock market.

Many Malaysians consider buying real estate one of their most important investments or major achievements on their way to “adulthood”. 

But the superiority bias could cause you to lose out throughout the life cycle of buying and selling property or other investments. 

First, you could overestimate your ability to analyse the real estate market and whether prices are increasing or declining in the future, and at which rate. 

Second, you could overestimate your ability to correctly appraise the actual value of the house. 

Third, you might be mistaken about your negotiation skills, versus those of your counterpart, as well as the willingness and ability to buy off other potential buyers. 

Fourth, you might wrongly assume the interest rate the bank is willing to give you, based on your financial situation and (future) employment status. 

But that’s not the end of it. 

Tens of years down the line, when you are looking to sell your property and you will learn whether your forecasts about your career and movements in the housing market have actually been realised, you will have to go through the same motions again. 

Understanding future movements of property prices, the value of your house, and your negotiation skills.

The same applies when you are investing in the stock market and believe you have the ability to beat the market. 

Due to transaction costs, much less than 50% of investments are actually beating the market and if you believe you have superior foresight, chances are, your counterparty with whom you are transacting believes this as well about his own skills.

So how can you prevent the superiority bias from hurting you financially? 

These are a few precautions you can take:

Be humble: accept you are not the smartest guy or girl in the room. I myself learned this in the most expensive way, with a real estate transaction which cost me dearly.

Involve other people: get multiple, conflicting points of view, to make sure you get a comprehensive amount of information before making a financial decision. Two heads know more than one.

Be content with less. If you can be satisfied with an average return on your investment instead of seeking to beat the market, you are less likely to engage in risky decisions which will hurt you down the line.

Mark Reijman is co-founder and managing director of dedicated to increasing financial literacy and to help you save time and money by comparing all credit cards, loans and broadband plans in Malaysia.

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