What Is Overconfidence Bias? 3 Types of Overconfidence Bias
Many people, from novices to experts, overestimate their own abilities in a particular trade. Psychologists call this the overconfidence bias, and it manifests in all corners of life, from politics to investment decisions.
What Is Overconfidence Bias?
The overconfidence bias, also known as the overconfidence effect, is a cognitive bias that makes people erroneously inflate their skills and knowledge. People who suffer from overconfidence bias have lost objective perspective of their abilities. This can impact their decision-making and their ability to evaluate their own work.
Researchers often measure a person’s overconfidence bias by asking them a question or having them perform a task while also asking them how confident they are that they are correct or capable. The researchers cite an overconfidence bias if they note a disparity between the person’s self-assessment and their actual competence.
3 Different Types of Overconfidence Bias
Overconfidence biases fall into three overriding categories.
1. Overestimation: This type of overconfidence bias describes a person’s tendency to estimate their performance or judgment as better than it actually is. The person operates with a heuristic that they are more capable than they really are. This could owe to a mistaken belief that they have more control than they do (the illusion of control), that they will accomplish a task in less time than it will really take (planning fallacy), or that they will achieve a particular outcome because that outcome is desirable.
2. Overprecision: This overconfidence bias refers to excessive confidence in one’s knowledge. Researchers measure overprecision by asking people to answer questions and then asking them to rate their confidence in their answers. A person with inflated confidence intervals—such as someone who believes they are correct ninety percent of the time but is only correct fifty percent of the time—suffers from an overprecision bias.
3. Overplacement: A person with overconfidence bias overrates themselves compared to others. This type of overconfidence heuristic, or mental shortcut, is especially prominent in financial services. Many traders, analysts, and advisors tend to believe that they are better than the average person in their profession. Statistically, this cannot be possible, as only fifty percent of a population can possess above-average skills.
While overconfidence bias plagues many people, it is just one of many cognitive biases that affect human behavior. Other common biases include the confirmation bias (where humans actively seek information that will confirm their extant feelings), the representativeness heuristic (a sometimes misleading mental shortcut where people equate new situations with past examples), and the availability bias (a tendency to compare events to those a person can readily recall).
3 Examples of Overconfidence Bias
The overconfidence bias manifests in both the controlled conditions of a study and the churn of daily life. Consider these three illustrative examples of the overconfidence bias.
1. Wealth management: Traders who buy and sell securities may not behave as informed, rational actors. Some traders suffer from an overprecision bias, which yields an inflated perception of their ability to interpret financial data. Their financial decision processes become skewed by hindsight bias, where they take credit for knowing things now that they didn’t know when making past decisions. Meanwhile, their forecasts draw too much from past performance without carefully considering new factors in the market. These biases prevent traders from making better decisions about their financial portfolios and those of their clients.
2. Entrepreneurship: Starting a business is risky and costly, and more new businesses fail than succeed. Yet part of the entrepreneurial mindset is the confidence that you will succeed where others haven’t. While this borders on overconfidence, it helps weed out people who lack the resolve needed to be an entrepreneur. This overestimation bias can stave off loss aversion, which is a feeling that prevents many people from taking the risks that come with entrepreneurship.
3. Self-serving bias: People with a self-serving bias take credit for their successes and blame outside forces for their failures. If your company has an especially good quarter of earnings, it’s tempting to attribute this success to your hard work and talent. However, whenever there are bad outcomes, it’s easy to blame a weak economy or the perceived laziness of other team members rather than yourself. While emotionally convenient, such thinking suggests a self-serving bias.