Why Smart People Make Poor Investment Decisions

Written by Josh Matthews, HBA

Recently I had a series of discussions with a very intelligent client who is a successful professional in private equity.  He recently spoke with me about an article he read about the Dunning-Kruger Effect, which resonated with him as he felt it accurately described his situation with respect to investing in the capital markets – which is very different to private markets.

He has been a client for many years but has not always followed investing best practices, has tried to apply his private equity mindset and made some behavioural errors like trying to time markets, change his risk tolerance, and pick stocks or asset classes from time to time.  Consequently, his portfolio has underperformed a similar discretionary portfolio with similar risk over time.

I think it’s fair to say that successful people, including myself, suffer from this effect when involved in situations that are outside of our areas of expertise. We try and use our intelligence and experience from other fields to make decisions that experts know are flawed. My wife is often very quick to point this out when I’m talking with car mechanics, builders, doctors, or other professionals!

If this resonates with you, please take a few minutes to read the linked article, which hopefully will make you a better investor and make better decisions in other situations:

Investopedia – Dunning-Kruger Effect: Meaning and Examples in Finance

There are, of course, many other behavioural issues all investors face, such as overconfidence bias, confirmation bias etc, that are very important to recognise some of which are discussed here:

Investopedia – 4 Behavioural Biases and How to Avoid Them

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