Behavioral Finance defines several investor biases that tend to inhibit financial success. The recent news of JP Morgan’s $2 billion loss demonstrates the danger that an overconfidence bias can be to your portfolio. Overconfidence bias is fairly self explanatory, but usually occurs when people believe they are smarter than others. Through the financial crisis, JP Morgan CEO Jamie Dimon was praised for keeping the company profitable. This may have led to overconfidence in both the CEO and JP Morgan employees, who overestimated their ability to hedge risks in derivatives trading. Dimon admitted to reporters, a “flawed, complex, poorly reviewed, poorly executed and poorly monitored” trading strategy.
The firm’s recent fall from grace illustrates how an overconfidence bias can negatively impact your portfolio. Making one or two great stock picks may lead an investor to think they have an edge and resist adherence to a proper allocation or diversification strategy. However, as history indicates, no one approach to investing produces superior returns year after year. Hot performance tends to shift from industries, countries, sectors and market caps; highlighting the need for a diversified long term approach. This also brings to mind the tired statement on the bottom of all of your account statements…”past performance is not a guarantee of future results.”
Stay tuned for more investor biases and the hazards they can have to your wealth…
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