Internet investing sites and tips give people a false - and costly - sense of their abilities, studies show. Legendary investor Howard Marks has a solution.
Social media leads investors to become overconfident and take on greater risk.
Social media can be hazardous to your wealth.
Researchers have found that social-media users tend to be less knowledgeable about finances and investments, overtrade their portfolios and incur excessive risk - all costly behaviors.
Correlation is not causation, of course. But a number of studies offer clues about the sources of the correlations. These studies can show how to remain on social media without it harming your investments.
Internet knowledge versus genuine knowledge
One such clue comes from a recent study in the Journal of Consumer Psychology. Entitled "I share, therefore I know?" the study was conducted by three researchers at the University of Texas: Adrian Ward, Jianqing (Frank) Zheng and Susan Broniarczyk. They focused on social-media users who share articles with others, finding that sharers often believed they were knowledgeable about the content of those articles - even when they hadn't read them.
The researchers called this false sense of knowing "subjective knowledge," and distinguished it from the "objective knowledge" that is gained by actually reading the articles and comprehending their content. They found that investors whose subjective knowledge was far greater than their objective knowledge - the most overconfident, in other words - tended to have dangerously high equity exposure levels.
A similar study, also co-authored by Adrian Ward, focused on what he and his co-authors called the "Google effect." Entitled "Confidence without competence," Ward's co-authors were Tito Grillo (of the University of Alberta) and Philip Fernbach (of the University of Colorado at Boulder). The researchers found that when investors use the internet to answer questions, they tended to attribute the knowledge to themselves - even forgetting they relied on the internet in the first place. This in turn led them "to think they know more than they really do." Similar to the conclusion reached by the study mentioned above, the authors of this one found that the overconfidence created by the Google effect leads investors to take on greater levels of risk.
Overtrading and unwise early withdrawals from your 401(k)
A related study, published in the Journal of Financial Planning, found that users of social media were significantly more likely to make 10 or more portfolio trades per month - every two trading days, on average. Those who trade that way often lag the market. Entitled "Who uses social media for investment advice?" the study was conducted by Miranda Reiter and Morgen Nations (both from Texas Tech University) and Di Qing (of Auburn University). They also found that social-media users were more likely to invest in highly risky microcap and penny stocks.
Another study found that these overconfident individuals were far more likely to take early withdrawals from their retirement accounts "without understanding [the] possible consequences." Those consequences include hefty penalties and a significant reduction in these individuals' eventual retirement standard of living. Entitled "Financial knowledge overconfidence and early withdrawals from retirement accounts," this study was conducted by Sunwoo Tessa Lee and Sherman Hanna, both of The Ohio State University.
The researchers focused on the 5% of investors whose subjective knowledge was furthest above their objective knowledge. Early retirement-account withdrawals were taken by 37% of this subset of overconfident investors, in contrast to just 5% of investors with the greatest amount of objective knowledge.
Dumb and dumber
A related study was published in May in the Journal of Business Research. Entitled "When thinking you're good makes you dumber," the study was written by three researchers at France's École de Management de Normandie: Damien Chaney, Magali Trelohan and David Moroz. They found that individuals whose subjective knowledge exceeded their objective knowledge were particularly closed-minded. They had a "tendency to select and process information in a biased manner," and to be "less open to new alternative viewpoints."
Being closed-minded is a bad idea in every walk of life, but it can be particularly harmful in investing.
How to overcome overconfidence
There are two ways to reduce overconfidence. The first is to increase our objective financial knowledge, and the second is to reduce our opinion of how much we know (our subjective knowledge). Of the two, the latter is far more important.
The investment manager who perhaps has done more than anyone on Wall Street to extol the virtues of humility is Howard Marks, co-founder and co-chairman of Oaktree Capital Management. It would be a good idea to read - and regularly reread - his articles on investment humility. A good place to start is his now-famous 2022 essay, "The illusion of knowledge."
A book-length treatment of these same issues appears in "The Knowledge Illusion," by Fernbach, the UC Boulder professor, and Steven Sloman, a cognitive scientist at Brown University whose research focuses on how people think.
Read the essay from Marks in its entirety. Don't just share it on social media after only reading its headline. And then add the Fernbach and Sloman book to your reading list.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
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-Mark Hulbert
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