There is a certain type of person. They are the kind that asks complicated questions about simple things without ever knowing what they mean. They conflate sounding smart with being wise. Despite the veneer of their ersatz expertise, I like to say these people know just enough to be dangerous.1 What do I mean?
A novice in any field is keenly aware of their own shortcomings in ways that often prevent them from making big mistakes.2 Their self-awareness (and, hopefully, their modesty) keeps their ambition in check. They know their lack of knowledge is a hindrance to their decision-making process and don’t take large risks. Their fear is inversely proportional to how much they think they know. They are not overconfident.
In personal finance and investing, the capacity to take on risk is wholly independent of knowledge, but knowing just enough to be dangerous can compound the problem and compel people to make foolish and costly decisions. Someone who knows absolutely nothing about investing isn’t likely to lose hundreds of thousands of dollars because they’d feel uncomfortable taking on that much risk about something they don’t understand.3 The dynamic changes when the person knows enough to think they can take on larger and larger risks. In many of these cases, they likely don’t understand 1) the full mechanics of investment they’re about to make 2) the true risk their taking 3) or both.
This is a devastating flaw, particularly because it is nearly impossible to distinguish between whether success in the markets is the result of luck or skill.4 Jim Paul’s What I Learned Losing a Million Dollars offers an excellent case study of how, in part, confusing luck and skill can, well, lead to losing a million dollars. Paul knew just enough about soybean oil speculation to be dangerous to himself (and his family).
Fortunately, there are plenty of antidotes for overconfidence. The world is more than happy to put a person in their place. The question is how much should such “therapy” cost. If you want to pay a steep price, simply invest lots when you know just enough to be dangerous. Otherwise, might I suggest trying to teach yourself something. It’s humbling. Or hang out with people who are smarter than you. I assure you there are plenty. Even better, try starting a blog about topic you know relatively little about. There’s no faster route to curative humility.
*My apologies to Carl Richards. I know sketches are totally your bag and all I can say is 1) I’m fully aware of how highly derivative my doodle is 2) I hope you find imitation to be the highest form of flattery 3) I promise not to make sketches a regular feature on this blog.
1Of course, psychology has a name for this: the Dunning-Kruger Effect.
2Or they don’t have the know-how or they haven’t accumulated enough resources to screw things up majorly. It appears recent research bears this out. From the Harvard Business Review: “Absolute beginners can be perfectly conscious and cautious about what they don’t know; the unconscious incompetence is instead something they grow into. In several studies, just a little experience replaced beginners’ caution with a false sense of competence.”
3However, someone who knows absolutely nothing could certainly lose a fortune being scammed.
4Michael Moubaussin writes about this extensively in The Success Equation: Untangling Skill and Luck in Business, Sports and Investing.