It’s easy for most people to accept that they do not belong to the top 1 percent or 5 percent in many fields – income, intelligence, health, strength, beauty, or humor. We can be realistic – to a degree. But it is very hard for people to accept that they do not belong to the top 50 percent.
In fact, if you ask people whether they belong to the top 50 percent of the population in any of these fields – driving skills, job performance, honesty, memory – 90 percent of people will say they do, which obviously doesn’t make sense. Statistically, only half of us CAN be above average. Voila: the superiority bias illustrated.
The superiority bias or illusion is sometimes called the “Lake Wobegon effect,” after a fictional town – created by author Garrison Keillor – where “all the children are above average, all the women are strong and all the men are good looking.”
It basically comes down to having an inflated view of ourselves; to believe we are much better in comparison to the general population than we actually are. We are optimistic about ourselves and realistic about others. Take your driving ability for example. Very few of us would rate our own driving skills below average. In an experiment in 1981, a Swedish professor surveyed 161 students asking them to compare their driving skills with those of other people in the experiment. Ninety-three percent put themselves in the top 50 percent and therefore, above the median.
While this is harmless in many ways, it can be extremely dangerous when it comes to managing your finances and investing. Let’s take a look at two popular examples here in the Philippines: buying real estate and investing in the stock market.
Many Filipinos (and many other nationalities) consider buying real estate one of their most important investments or major achievements on their way to “adulthood.” But the superiority bias could cause you to lose out throughout the life cycle of buying and selling a property or other investments.
First, you could overestimate your ability to analyze the real estate market and whether prices are increasing or declining in the future, and at which rate.
Second, you could overestimate your ability to correctly appraise the actual value of the house.
Third, you might be mistaken about your negotiation skills, versus those of your counterpart, as well as the willingness and ability to buy off other potential buyers.
Fourth, you might wrongly assume the interest rate the bank is willing to give you, based on your financial situation and (future) employment status.
But that’s not the end of it.
Tens of years down the line, when you are looking to sell your property and you learn whether your forecasts about your career and movements in the housing market have actually been realized, you will have to go through the same motions again: Understanding future movements of property prices, the value of your house and your negotiation skills.
The same applies when you are investing in the stock market and believe you have the ability to beat the market. Investing your savings in shares listed on the Philippine Stock Exchange is widely popular in the Philippines and fueled by investment advocates urging people to invest in “blue-chips” and “mutual funds.”
Remember, the stock market is bound to improve because the country is growing and the returns over the past five years have been great, right?
Due to transaction costs, much less than 50 percent of investments are actually beating the market and if you believe you have superior forecasting abilities or information, chances are, your counterparty with whom you are transacting believes this as well with regard to his own knowledge and skills.
So how can you prevent the superiority bias from hurting you financially?
Here are a few precautions you can take:
Accept you are not the smartest guy or girl in the room. Being humble is not a weakness but a great strength that can give you the edge over your counterparty in both real estate and stock investing.
Involve other people:
Get multiple, conflicting points of view, to make sure you get a comprehensive amount of information before making a financial decision. Exhaust all possible channels to get as much information as possible. Multiple heads often know more than one.
Be content with less:
If you can be satisfied with an average return on your investment, instead of seeking to beat the market, you are less likely to engage in risky decisions, which will hurt you down the line. Remember, if you expect less and make more, your satisfaction level will be significantly higher.
Moritz Gastl is the managing director of MoneyMax.ph, a financial comparison website aiming to help Filipinos save money through diligent comparisons of financial products.