Every month is an excellent time to improve your financial literacy.
This month, though, there is a special emphasis on it because October is National Retirement Security Month. A key purpose of the U.S. Senate resolution designating the month is to increase the personal financial literacy of all persons in the United States.
Of course, financial literacy has been alarmingly low for years, so this need is not new. Nonetheless, our collective financial literacy looks to be attacked by a new and very modern threat: the internet. The internet is causing you to be a poor investor.
According to a study published on the Social Science Research Network (SSRN), the internet drives investors to believe they know more than they do. Overconfidence causes their portfolios to perform poorly. This remarkable study was introduced to me by Joachim Klement, former head of equity strategy at UBS Wealth Management and trustee of the CFA Institute Research Foundation.
SSRN study authors Adrian Ward, a marketing professor at the University of Texas at Austin, Tito Grillo, a professor of business economics and law at the University of Alberta, and Philip Fernbach, a marketing professor at the University of Colorado, wrote, “Confidence Without Competence: Online Financial Search and Consumer Financial Decision-Making.”
In various phases, the study arrived at its startling conclusion:
The study demonstrated that when people use the internet to answer questions, they credit the information they gained from the internet to themselves. That’s because, after utilizing the internet to hunt for information, individuals tend to forget about it. The Google effect refers to blurring internal and external knowledge boundaries, leading people to believe they know more than they do.
The researchers then demonstrated that the Google effect causes investors to overestimate their abilities. They proved this by splitting a sample of investors into two otherwise similar groups based on whether they had an internet connection when completing an investing knowledge test and then presenting each group with the same investment challenge. After constructing their portfolios, the investors were asked how much money they would stake on their portfolios’ future success. Unsurprisingly, individuals who had access to the internet performed better on their tests than those who did not. Furthermore, this higher-scoring group wagered more on the performance of their investment decisions on average, showing greater confidence in their investing ability.
However, the overconfidence of the higher-scoring group was mistaken. The researchers discovered that, on average, investors in this group achieved much lower returns than those in the other group. This is the situation referred to in the study’s title as “confidence without competence.” The higher-scoring group’s lower return appears to be due to their greater readiness to take risks.
This new study emphasizes the hazards of arrogance and the benefits of humility. The internet causes us to boost our self-esteem without our knowledge. Even those of us attempting to avoid the perils of overconfidence may be led down the primrose path.
It is not an unintended consequence of the internet. “We want Google to be the third part of your brain,” according to Google co-founder Sergey Brin. As explained by the authors of this study, Google blurs the boundaries between the information that lives in one’s mind and the knowledge that resides on the internet.