#12: How Overconfidence Can Be Disastrous

UNSINKABLE 

It’s mid-April 1912, and the unthinkable has happened: The Titanic has sunk. Over 1500 people have perished in the icy water, with only 800 aboard the lifeboats. Why was the Titanic so unprepared for disaster?

To explain, let’s investigate a classic experiment from 1965 involving clinical psychologists and psychology students. These participants were drip-fed information about a patient over 4 stages and asked to make clinical judgements through a series of multiple-choice questions, whilst also rating their likelihood of being correct.

Through the stages, the subjects’ accuracy hardly improved - remaining below 30%. However, their confidence increased significantly - from 33 to 53%. Interestingly the clinical psychologists didn’t perform any better than the students, however they grew the most confident with the extra information.

The cognitive bias shown is known as the ‘overconfidence effect’ and causes people to overestimate their performance or predictive capabilities.

We see it with car drivers – in one study, 93% of drivers rated themselves as above average! We experience repeated safe car trips and conclude our skills must be superior, without factoring in that statistically car journeys are thankfully quite safe for everyone.

Another multi-year study from 2017 asked top corporate CFOs to predict 12-month stock market performance. Firstly, they performed poorly – in fact they did slightly worse than if they had just flipped a coin. 

Secondly, when asked to predict a range of values that they were 80% confident the stock market would finish within, they were right only 33% of the time. Or to put it another way -- they were ‘surprised’ two thirds of the time!

Overconfident CEOs and CFOs would take on more debt, take more risks and pay more for acquisitions. Recent success and media admiration only added to their conviction.

The scary thing is that we prefer certainty over reality, especially when the stakes are high. Overconfident experts, doctors and politicians get hired more than experts who explain the true situation. This provides us with an illusion of safety and control, even if the actual risks are higher.

Finally, how did overconfidence affect the Titanic? Disastrously, the owners believing the ship to be practically unsinkable reduced the number of lifeboats to improve passenger views and the general aesthetic!

WISDOM 💎

"No problem in judgment and decision making is more prevalent and more potentially catastrophic than overconfidence." It has been blamed for lawsuits, strikes, wars, poor corporate acquisitions, and stock market bubbles and crashes.

Scott Plous

Tip 1 - A SMART PLAY ✅

Recognise your limits. Build in a margin of safety in case you're wrong. Charlie Munger explains that you can get tremendous long-term advantage by just trying to consistently not be stupid, as opposed to trying to be brilliantly intelligent.

Tip 2 - AVOID 🚩

Getting carried away by extremely charismatic and convincing leaders. Intuitively we are naturally drawn in by confidence and certainty. Separate the reasoning from the person and breakdown what is really being said.

Tip 3 - ACTION 💪

Conduct a premortem. Before committing to an important decision, Gary Klein suggests a premortem as follows: 12 months have passed and the plan you have implemented has been an unmitigated disaster. Write a brief history of all the things that have gone wrong. The premortem legitimises doubt and throws up unseen problems.