Bridging the confidence gap: financial literacy vs. investor overconfidence

Bridging the confidence gap: financial literacy vs. investor overconfidence
Even clients with high investment knowledge can make risky portfolio decisions. Advisors can provide a much-needed reality check.
JAN 13, 2025

Financial advisors know well that a foundational level of financial literacy is essential for making informed investment decisions. Yet, even with strong literacy scores, many investors are prone to overconfidence – an emotional bias that can have significant implications for their financial outcomes. Advisors are uniquely positioned to bridge this confidence gap, helping clients turn knowledge into sound, unbiased decision-making.

Recent survey findings from Janus Henderson Investors reveal a striking dynamic: most investors can correctly answer basic financial literacy questions on topics like diversification, inflation, and compounding. However, when asked to self-assess their financial aptitude, many overestimate their capabilities. This phenomenon of overconfidence often results in poor decision-making, such as taking on excessive risk or pursuing over-concentrated investments.

For instance, the survey explored investor preference between two hypothetical portfolios. One consisted of the seven largest U.S. technology companies – the “Magnificent Seven” – while the other comprised 493 other large U.S. companies. Overconfident investors disproportionately favored the tech-heavy portfolio, undervaluing diversification for perceived higher potential gains. This choice underscores how overconfidence can lead to an underestimation of risk and over-reliance on recent market trends.

Advisor implications: the power of education

Overconfidence is not necessarily a barrier—it can be an opportunity. Research shows that overconfident individuals often express a high interest in financial education. Among our survey respondents, 87% were eager to increase their investment knowledge, with those exhibiting overconfidence showing the strongest interest. This creates a unique opening for advisors to guide clients toward a deeper understanding of financial principles while addressing emotional biases.

Through education, advisors can help clients identify and mitigate the effects of overconfidence. Discussions around concepts like portfolio diversification, long-term planning, and risk tolerance can provide a reality check, empowering clients to approach their investments with clarity. Interactive tools like risk assessments or scenario modeling can further demonstrate how overconfidence may cloud judgment, bringing the potential consequences of impulsive decisions into sharper focus.

The survey also highlights a gender disparity in financial confidence. Male investors, on average, demonstrated higher levels of overconfidence than female investors, despite similar financial literacy quiz scores. Women tended to rate their financial knowledge more conservatively, even when their answers indicated a strong understanding of key concepts. When asked to rate their level of financial knowledge on a scale of 1 (beginner) to 7 (highly knowledgeable), the mean score for women was a 4.2, compared to the male score of 5.

Strategies for closing the confidence gap

Advisors can employ the following five strategies to help clients balance confidence with competence:

  1. Encourage objective assessments: use tools like financial literacy quizzes or investment simulations to provide clients with a clear picture of their actual knowledge and how it compares to their self-assessment.
  2. Promote diversification: highlight the benefits of diversified portfolios through historical performance data, showing how a balanced approach often outperforms concentrated bets over the long term.
  3. Leverage behavioral insights: explain common cognitive biases, such as overconfidence or recency bias, to help clients recognize how these may influence their decisions. Use real world examples of how cognitive biases have impacted clients.
  4. Offer tailored education: provide resources, workshops, or one-on-one sessions on topics like risk tolerance, asset allocation, and market cycles to deepen client understanding. Don’t just be their quarterback; be their coach!
  5. Build trust through collaboration: foster an environment where clients feel comfortable sharing their concerns and uncertainties. Trust is essential for clients to acknowledge their blind spots and accept guidance. Always be encouraging, but also realistic.

Overconfidence can seem like a roadblock, but it also signals an opportunity for engagement. Advisors can guide clients in transforming self-assuredness into informed decision-making. By addressing emotional biases, promoting financial literacy, and encouraging balanced strategies, advisors can help clients achieve their goals while avoiding the pitfalls of overconfidence.

For financial professionals, this work is not just about mitigating risks, it’s about fostering meaningful, long-term partnerships that empower clients to succeed. By bridging the confidence gap, advisors can ensure that their clients’ knowledge leads to better outcomes, not bigger mistakes.

 

Matt Sommer is head of the specialist consulting group at Janus Henderson Investors.

Latest News

SEC prepares to back away from defending climate rule in court
SEC prepares to back away from defending climate rule in court

Acting Chairman Mark Uyeda directed SEC staff to initiate a pause in court while the commission awaits a quorum. The SEC may decide to withdraw from defending itself in a lawsuit over last year's climate disclosure rule.

wealth.com welcomes Kathy Wunderli in private wealth push
wealth.com welcomes Kathy Wunderli in private wealth push

The top estate planning platform's veteran hire will lead its legal team's efforts to develop estate planning, tax analysis, and wealth transfer solutions for ultra-high-net-worth clients.

Morgan Stanley loses $843,000 investor claim stemming from 'gold bar' scam
Morgan Stanley loses $843,000 investor claim stemming from 'gold bar' scam

“If Morgan Stanley had called my client’s son, this wouldn’t have happened,” the investor's attorney said.

LPL welcomes $630M sibling advisor duo from Corebridge
LPL welcomes $630M sibling advisor duo from Corebridge

Meanwhile, Ameriprise has bolstered its own ranks as an LPL defector joins its branch channel in California.

Treasuries fall as Powell reaffirms rate-cut patience
Treasuries fall as Powell reaffirms rate-cut patience

The Fed chair's continued signals to delay policy easing sent 10-year yields higher, with money markets pricing in just one quarter-point cut this year.

SPONSORED Taylor Matthews on what's behind Farther's rapid growth

From 'no clients' to reshaping wealth management, Farther blends tech and trust to deliver family-office experience at scale.

SPONSORED Why wealth advisors should care about the future of federal tax policy

Blue Vault features expert strategies to harness for maximum client advantage.