Simply put, this behavioural finance concept is the tendency of people to overestimate their ability to control a situation, often leading them to make decisions that are far riskier than they anticipate. This concept can be used to illustrate the behaviour of investors who draw some unwarranted conclusions about the future direction of the stock market – and make potentially risky decisions about their portfolios in response.

With the strong stock performance we have seen since March, we don’t want to become overconfident and assume that the threat of a correction is over – that the market has overcome the impact of the coronavirus and is destined to remain strong. On the other hand, we also should not be overconfident and assume that a correction is imminent – that the market is destined for a tumble simply because it has recently been strong.

I believe the best antidote for Overconfidence Bias is to have a long-term investment plan – one that includes your portfolio being well diversified. That means broad diversification across a variety of asset classes as well as broad diversification across the globe. By staying focused on your long-term goals – and staying prepared for both positive and negative market movements along the way – you will be less tempted to take the bait and change strategies if/when you believe the markets might change direction.

Different asset classes and geographic regions preform differently through different market cycles. By diversifying your portfolio, you can access the better performers while mitigating the risk of being over concentrated in the sectors that might lag.

Below are two charts, the first shows performance by asset classes, the second by country. Each asset class/country is represented by a colour, by focusing on the colours you can see how the asset classes/countries vary in their performance year to year.  This illustration demonstrates why it is so important remain diversified regardless of how the markets look in the short-term.

Performance by Asset Class

Performance by Country

Regards,

Tracey

Sources: Invesco Canada blog by Kristina Hooper posted 08-24-2020, Dynamic funds website

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