The worse we are at any specific skill set, the harder it is for us to evaluate our own competency at it. This is called the Dunning–Kruger effect. This precise sort of cognitive deficit means that areas we are least skilled at – let’s use investing decisions as an example – also means we lack the ability to identify any investing shortcomings. As it turns out, the same skill set needed to be an outstanding investor is also necessary to have “metacognition” – the ability to objectively evaluate one’s own abilities. (This is also true in all other professions.)
Unlike Garrison Keillor’s Lake Wobegon, where all of the children are above average, the bell curve in investing is quite damning. By definition, all investors cannot be above average. Indeed, the odds are high that, like most investors, you will underperform the broad market this year. But it is more than just this year – “underperformance” is not merely a 2011 phenomenon. The statistics suggest that 4 out of 5 of you underperformed last year, and the same number will underperform next year, too.
Underperformance is not a disease suffered only by retail investors – the pros succumb as well. In fact, about 4 out of 5 mutual fund managers underperform their benchmarks every year. These managers engage in many of the same errors that Main Street investors make. They overtrade, they engage in “groupthink,” they freeze up, some have been even known to sell in a panic. (Do any of these sound familiar to you?)
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