How Overconfidence Affects Investors and Their Returns

This article was written in 2017 and updated on 5 September 2025 to reflect current behavioural finance research, recent market evidence and Netwealth’s latest planning guidance.

Key Takeaways

Overconfidence narrows judgment and often worsens investment results
Excess trading market timing and concentrated bets are common pitfalls
Evidence shows men tend to trade more and earn lower net returns
Staying diversified and keeping costs low helps counter behavioural errors
Using a disciplined process and clear financial planning reduces bias

Being confident often allows us to function to the best of our abilities, unhindered by doubt. Yet simply firing that emotion up a notch can have disastrous consequences for our money and our lives. Overconfidence can lead us into all sorts of trouble.

“Almost everyone's instinct is to be overconfident and read way too much into a hot or cold streak”Nate Silver, statistician and author, The Signal and the Noise

We have high opinions of ourselves

We have a tendency to elevate our self-belief. Several studies have shown that overconfidence consistently leads us to an explicit disparity: the difference between what we think we know and what we really know. After researching its impacts for two decades the behavioural economist Richard Thaler noted in 1995, “Perhaps the most robust finding in the psychology of judgment and choice is that people are overconfident.”

A famous analysis by the research scientist Ola Svenson in 1981 confirmed this assertion. In a report entitled, “Are we all less risky and more skilful than our fellow drivers?” it found that 93% of American drivers rate themselves as better than the median.

Nobody is immune from its effects. In a 2005 study¹ the finance professors Ulrike Malmendier and Geoffrey Tate argued that personal characteristics of CEOs in large corporations lead to distortions in corporate investment policies. They stated that overconfident CEOs systematically overestimate the return on their investment projects.

Numerous tragedies and chaotic events – ranging from the Titanic sinking to the Chernobyl disaster to the global financial crisis – have been linked to excessive levels of confidence (and the related optimism bias). Participants, and so-called ‘experts’ in particular, rarely believe such outcomes can occur.

Nobel prize-winning psychologist Daniel Kahneman called overconfidence “the most significant of the cognitive biases”. He stated in a Guardian newspaper interview in 2015 that if he had a magic wand, overconfidence would be the human bias he would most like to eliminate.

It is only natural, therefore, to assume that the effects of this powerful behavioural trait also have severe consequences for our money.

How overconfidence can affect our finances

Overconfident investors can be impervious to their shortcomings. This can lead them to trade excessively because they believe they have the skills to time the market, which is usually a mistake. A costly mistake.

In the 30 years to the end of 2016, a study by DALBAR (QAIB) found that the average equity investor earned around 4% per year compared with a market return of about 10% per year, a gap largely explained by poor timing decisions. More recent editions of QAIB indicate the behaviour gap persists through 2023.

In this respect, the overconfidence bias also reveals a gender bias. Research for The Quarterly Journal of Economics² discovered that men trade 45% more than women, with trading reducing men’s net returns by 2.65% a year and lowering women’s by 1.72% a year.

While the percentage difference seems minor, even a 1% effect on our portfolios each year makes a significant impact over time.

Other results of overconfidence include being poorly diversified by placing too much conviction in a limited number of stocks, and being more prone to the bias of loss aversion: our certitude can make us hold on to a failing investment for too long because we are convinced it will recover.

Lessening the effects of overconfidence

Ideally, investors should chart a course between imprudence and timidity. Yet simply recognising that we can be prone to overconfidence is one of the best ways to deal with its effects. We should also not pay too much attention to others who display excessive confidence or conviction.

Finally, we may minimise the consequences of overconfidence and other biases by assigning a company to invest on our behalf. For Netwealth’s part, we focus on constructing efficient, diversified portfolios, understanding that the trading costs incurred by emotive responses to market events can significantly reduce investment performance.

Latest evidence on overconfidence

Since this article was first written, new research has expanded our understanding of how overconfidence affects investors and markets. Key findings from 2024 and 2025 include:

Behavioural finance research shows overconfidence continues to drive excessive trading across equities, mergers and acquisitions and cryptocurrencies, acting as both a source of risk and of innovation
A 2025 study in Japan found that investors with higher confidence levels were more likely to panic sell during downturns, even when financially literate
A validated 30-item scale now measures three distinct types of overconfidence in investment decisions, offering a stronger framework for future analysis
New evidence from the COVID-19 crash confirms investors who overrated their financial knowledge were more likely to sell during the March 2020 sell-off
A systematic review of 137 studies finds that retail investor overconfidence is shaped by demographics, personality and experience, and remains difficult to correct

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Please remember that when investing your capital is at risk.

¹ Malmendier, U., & Tate, G. (2005). CEO Overconfidence and Corporate Investment. Paper PDF.
² Barber, B., & Odean, T. (2001). Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment. Paper PDF.

Additional evidence: DALBAR, Quantitative Analysis of Investor Behavior, 30th Annual Report (1985–2023). Press release. Kahneman interview on overconfidence bias: The Guardian. Nate Silver quote attribution: BrainyQuote.

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