Overconfidence is a huge problem when it comes to making investment decisions. In fact, it’s a huge problem when we’re dealing with any issue that has an unknown outcome. It’s clear that we’re very bad at dealing with unknown outcomes, but the biggest problem is that we actually think we’re good at it.

We think that we can control much more than we can, and we can actually forecast the future. Often we point to what we view as clear evidence and wonder how anyone that doesn’t see it the same way can be so stupid. Other times we base this superior ability on what we call a “gut feeling.” Then, every once in awhile, we turn out to be right (pure chance), and we remember that for a long time as say to ourselves and anyone that will listen to us:

“I know it all along.”

“I have a really good feel for these things.”

“I just think the market is going to go up.”

“It feels like things are clearing up.”

No where is this problem more evident than amongst economists. The recent deluge of “Crash Porn” books has given us ample insight into the painful consequences of being overconfident in pet models or Nobel prize-winning research.

For those of us with real lives who don’t have the time (or the interest) to read all these books on the crisis and it causes, a recent post on the Wilmott (a quant research firm) blog provides a nice review of many of the most popular “crash-lit” books written recently.

For those of you that are even too busy enjoying your lives to read the article, here’s a few interesting quotes from the post that sum up the entire thing:

• P.J.O’Rourke described economics as “an entire scientific discipline of not knowing what you’re talking about.”
• Unfortunately in the prediction stakes no economist can claim the prescience of Pope Benedict XVI. According to Italian Finance Minister Giulio Tremonti (as reported on Bloomberg News (20 November 2008)), the Pope, then merely Cardinal Joseph Ratzinger, in an article written in 1985 predicted that “an undisciplined economy would collapse by its own rules.” It is unclear which crisis the Holy Father was predicting, but given papal infallibility, probably all of them.
• Warren Buffet observed that: “…not only does a sky-high IQ not guarantee success but it could also pose a danger…I therefore urge the relevant regulatory bodies of the United Studies and Canada to incorporate an IQ test into their securities licensing exams. … nobody would be allowed to work in the financial markets in any capacity with a score of 115 or higher. Finance is too important to be left to smart people.”