Overconfidence bias is one of the most subtle and costly heuristics in finance. It can quietly shift confidence into something that convinces us that our instincts are more reliable than facts, that we know more than we do, and that success in one field guarantees it in another. It seems like clarity, but in reality, it makes us overlook complexity. That shift into overconfidence is one of the most common reasons investors take unnecessary risks. It’s also one of the biggest lessons highlighted in Rational Finance.

What Is Overconfidence Bias?

Overconfidence bias is the tendency to overestimate our abilities, knowledge, judgment, or level of control more than what is objectively reasonable. For example, someone may assume they can repair a vehicle because they’re skilled at fixing computers, without considering the differences between the two activities. Another example would be a student who believes they don’t need to study for an exam, only to fail the test. 

Overconfidence bias can appear when we assume we understand something simply because we understand something else. The brain relies on shortcuts called heuristics to avoid overwhelming itself and save energy. We use knowledge gained from past experiences and generalizations we’ve formed about the world to move quickly rather than slowing down to test assumptions. Most of the time, this helps us function efficiently. In investing, however, it can get us into trouble.

Why Are We Prone To Overconfidence Bias With Our Finances?

Financial decisions carry uncertainty, which tends to trigger anxiety, hesitation, and decision paralysis. Overconfidence bias allows us to bypass the uncomfortable feelings that come with indecision and anxiety. It gives us a sense of control and lets us continue forward on our path, but at the cost of not having a full, objective picture. In the moment, that sense of control feels productive. In reality, it often means we stop asking the questions we should be asking.

The brain naturally looks for the quickest route to an answer. If two steps get us 80% of the way to a goal, we tell ourselves that is good enough. The extra steps that would get us to 100% can feel tedious or unnecessary, and we reason with ourselves that the time and energy saved is worth it. 

That tendency is even stronger when we look at industries or tasks we’re not experienced with. Watching an expert perform their craft makes the work look simple enough for anyone to do, but we don’t see the years of experience, the trial and error, and the knowledge that make the process appear so effortless from the outside.

Confidence helps people take necessary risks, but overconfidence blurs the limits of what we actually know. It creates the impression that our intuition can replace research. It encourages us to rely on past successes in unrelated fields. It also gives us the false sense that understanding one market means we can understand all others just as easily.

How Does Overconfidence Bias Lead To Poor Investment Decisions?

Confidence is essential to our success because it emboldens us to take risks that help us grow. However, overconfidence narrows our focus and creates blind spots. When we believe our intuition or past success is enough to guide a new decision, we underestimate the role of context. We can also believe that our understanding of financial markets, industries, or investments is so great that we don’t need expert financial advice or solid data for direction and insight. 

The underlying forces, such as demand cycles, that drive the performance of one market are often drastically different from the forces of another. Failing to understand this can stymie the growth of a new venture and even lead to a total loss.

We often see context being overlooked when investors are seeking to expand their horizons and break into another industry, such as real estate. Even seasoned businesspeople can easily fall into the trap of overconfidence if they’re not careful. 

Say someone has spent their life as a master shipbuilder. This person has built great acclaim, as well as a healthy savings account. When they eventually retire from this hard work, they seek a new venture: luxury real estate development. Building condos on land can’t be too different from building boats, right? So they pour pretty much all of their money into this new investment, expecting a strong turnout. But what they fail to realize is that demand is variable in certain industries, real estate being an especially strong example. When conditions shifted, demand plummeted, and they lost it all.

The lesson of the story exemplifies how success in one field can trick us into overlooking risk in another. You may be reading this and think, “I’d never do anything like that”, but the truth is, we all fall under the spell of our own cognitive biases at times. We’ve all flown too close to the sun. The resultant issues are not always as drastic as losing your whole investment, but none of us is totally immune to the possibility of something going wrong due to overconfidence. The only way around it is balancing a healthy dose of confidence with humility and caution.

And remember, overconfidence isn’t malicious. It is simply what happens when confidence goes unchecked. 

You can find all the details of the shipbuilder’s $60 million mistake, as well as other stories from where psychology and finance intersect, in my new book, “The Lobster League”, coming out soon.

What Are Some Examples Of Overconfidence Bias In Finance?

Markets reward patience, but good economic times can distort our sense of skill, leading to overconfidence bias. When stocks are rising across the board, new investors often assume their gains are the result of their own strategy rather than favorable conditions. They may begin to frequently trade stocks, underestimate risks and volatility, and ignore sound advice. These actions can cause high costs and lower returns.

Overconfidence bias can also lead to concentrated portfolios and aggressive bets on industries that appear unstoppable. They may invest too heavily in one sector that they’re convinced will continue to do well. If that sector has a downturn, they may lose all of their investments because of the lack of a diversified portfolio.

Overconfidence convinces investors that they will spot turning points in time, but no one controls the market. Even strong companies can fail during a major downturn. The Dot Com bubble of the late 90s saw rapid growth with many investors pouring money into website stocks, only for it to burst when the Federal Reserve raised interest rates, causing many websites to disappear. Large financial institutions were thriving in the early 2000s, yet many closed during the 2008 recession. 

How Can We Avoid Letting Overconfidence Bias Take Over?

Overconfidence bias can cloud judgment and lead to costly financial mistakes. Addressing this bias involves honest self-assessment, diversifying risk, and maintaining a focus on long-term value. Don’t avoid confidence, but rather balance it with humility and structure. 

Be Realistic About Your Expertise & Expectations

It’s important to practice humility and regularly reflect on your experience, recognizing both strengths and limitations. If you are considering investments outside your field, assume there are risks you cannot see without support. Work with a trusted advisor, such as at PFW Advisors, ask for honest insights, and be open to constructive criticism. You won’t fully understand the impact of your financial decisions in an area in which you’re not an expert. Market conditions have more influence over outcomes than most people expect, so study those conditions before assuming your decisions will outweigh them.

Avoid Overexposure To Risk

Understand the inherent risks of certain industries, and don’t overexpose yourself to potential downturns. For example, real estate can be rewarding, but it’s also volatile. A single property or development project can become vulnerable if interest rates rise, if construction costs spike, or if demand falls. Spreading investments across various asset classes, sectors, and geographic regions helps to protect and diversify your portfolio. Rational investors structure their portfolios so that a setback in one area doesn’t compromise everything else, and regular reviews of your portfolio allow you to spot any unnecessary risks and rebalance your assets.

Focus On Long-Term Valuation

Warren Buffett, often referred to as the godfather of understanding the valuation of companies, is known for grounding decisions in fundamentals rather than short-term earnings, and his approach aligns with Rational Finance. Assess the basic fundamentals of a company, such as earnings quality, cash flow, return on equity, and the company’s sustainable advantages, instead of focusing on recent stock performance. Buffett’s approach emphasizes buying companies below their intrinsic value based on durable fundamentals and holding them for years rather than quick gains or following trends. This long‑term mindset pushes back against overconfidence bias by anchoring decisions on data and numbers rather than emotional decision-making.

Overconfidence bias is not a flaw. It’s human nature. The key is recognizing when it starts to shape decisions that require expertise, patience, and objective analysis. Rational Finance helps investors examine their assumptions, understand risk, and make decisions that support long-term stability. To explore how Rational Finance can guide your investment strategy, connect with PFW Advisors. We can help you make confident decisions grounded in data, valuation, and long-term planning.

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