Humans exhibit a cognitive bias known as the Dunning-Kruger effect, which leads individuals lacking skills or knowledge in a specific domain to draw erroneous conclusions while remaining oblivious to their own inadequacies. Novices often overestimate their ability and competence, while experienced and skilled individuals tend to underestimate their own capabilities.
Research conducted by David Dunning and Justin Kruger of Cornell University has shed light on this paradoxical phenomenon, revealing a two-fold pattern. Firstly, individuals with low ability lack the skills to accurately evaluate their own performance, resulting in inflated self-assessments. Secondly, due to their limited knowledge and experience, they struggle to recognize higher levels of competence in others.
A notable observation is the inverse relationship between competence and confidence, as depicted in the graph. The less competent someone is, the more confident they tend to become, whereas the more competent someone is, the more humble they become regarding their knowledge and experience.
Interestingly, true experts never reach the same level of unwarranted confidence displayed by novices. The Dunning-Kruger effect significantly impacts the quality and integrity of the decision-making process.
This “illusion of knowledge” can lead to poor decision-making and unintended consequences. This effect is evident in the field of financial advising, with advisors falling on both ends of the competence curve. It becomes problematic when experienced advisors underestimate their value in the decision-making process. They lack arrogance and understand the complexity of managing clients’ finances. Good advisors “zoom out” and bring perspective when markets decline. Experienced advisors tend to undersell themselves.
Conversely, there are advisors with low competence who exude confidence and make bold predictions about market trends and outperformance. Unfortunately, investors often mistake this confidence for competence, leading to misguided decisions.
The first step in addressing this paradox is recognizing and becoming self-aware of one’s position on the competence curve. We all start on the “Low Competence-High Confidence” side and progress over time. However, in domains like investing, this evolutionary process can be costly for the average investor. It is unnecessary to learn solely from personal mistakes. Lack of awareness of one’s limitations can lead to costly lessons.
Blind spots, by their nature, are invisible to oneself. Hence, it is advisable for investors to seek the services and guidance of a trusted advisor with relevant experience and knowledge. Understanding where one stands on the competence curve is crucial for fruitful conversations between the advisor and client. The average investor typically finds themselves on the novice side of the paradox and should be mindful of this when interacting with their advisor. Overestimating one’s competence undermines the advisor’s experience and wisdom, leading to unproductive conversations.
The average investor often focuses on immediate events and seeks active responses, which contradicts the principles of long-term investment wisdom. They “zoom in” on the noise of the day. Acting on short-term instincts can result in poor judgment and unfavourable outcomes. An experienced advisor helps investors “zoom out” to regain perspective and recommit to an agreed-upon investment discipline that maximizes the likelihood of achieving long-term goals.
I urge advisors not to allow themselves to be intimidated by individuals with less understanding and experience. Your guidance holds immense value for investors, and appreciating and valuing your expertise is vital.
I implore investors to acknowledge that they engaged the services of an advisor based on their experience and understanding of the complexities of the investment landscape. Instead of summoning your advisor for every market fluctuation, influenced by documented human biases and emotionally charged media coverage, exercise trust in their expertise.
As someone who has learned valuable lessons over the years, now in my 50s, I appreciate the complexity of my environment and recognize my own limitations. I am aware that the confident bliss I experienced at age 17 will, fortunately, never be mine again.
In the words of George Bernard Shaw, “Beware false knowledge; it is more dangerous than ignorance.”
The above article was written and adapted by Marius Kilian.
*”The Dunning-Kruger-Effect: A Hitchhiker Guide to Human Incompetence”, Charles Macnish, medium.com, April 2017