Wikipedia defines Illusory Superiority as:

a cognitive bias that causes people to overestimate their positive qualities and abilities and to underestimate their negative qualities, relative to others.

This bias runs rampant in areas such as intelligence, memory, cognitive tasks, academic ability, and job performance, popularity, and health.

In two U.S. studies of people's opinions of their own driving ability, over 80% rated themselves as above average.

In a study on interpersonal popularity, results showed that the participants generally had exaggerated perceptions of their own popularity, particularly in comparison to their own friends.

And so it is with investment acumen.

Numerous studies have concluded that the majority of mutual fund managers (supposedly the "smart money") fail to beat a comparable but passively managed index.

Even more telling, the majority of investors in a given fund fail to match the performance of the fund (because of ill-timed movement from one investment to another, the typical
"dollar-weighted" return trails the fund's "time-weighted" return).

Not every investor can be above average.  In fact, because of expenses and taxes, and an unfounded superiority complex, the majority of investors will be below average.

So what to do?

• Admit you aren't any smarter than the consensus of all other investors (ie, the market).
• Resolve not to play "the loser's game" (trying to beat the market) and instead invest in a diversified portfolio of low-cost index funds.
• Whenever you hear a stock tip (or other "hot investment strategy"), ask yourself "if that's such a great investment, why would he tell me about it?"

"Dishonest money dwindles away, but he who gathers money little by little, makes it grow."
-- Proverbs 13:11 

There's an often-used expression in the investment world that goes something like this:

"Getting into a stock is easy but you need to have an exit strategy... know when you are going to get out."

Most investors and many stock analysts translate this into a "price target" for their stock picks.

How sadly naive.

A price target by itself does absolutely nothing for you; it falsely attributes a price increase with a return to "fair value."
A stock's price is only a measure of what the current market consensus is.  There's no reason to believe that a change
in price, up or down, to any degree, equals a more accurate measure of "value." 

If you are going to engage in either trading or investing in individual stocks (I strongly discourage you from doing either), at least
come up with a sell trigger that is based on one or more intrinsic factors (other than price).  Price-earnings ratio, future earnings estimates, balance sheet measures, etc.

Such triggers operate under the misguided assumption that stocks frequently and flagrantly trade away from their actual "value" (the value of anything is how much
someone is willing to pay you for it at that moment which is known as the "market price"), but at least they are based upon a logical construct (even if the premise is flawed).

"Of what use is money in the hand of a fool, since he has no desire to get wisdom?"
-- Proverbs 17:16

I have two articles on my desk that are next in my queue of professional reading:

Adaptive Asset Allocation Policies by William Sharpe and

Mean-Variance Versus Mean-Conditional Value-at-Risk Optimization: The Impact of Incorporating Fat Tails and Skewness into the Asset Allocation Decision by Xiong and Idzorek.

I have not provided links because it's unlikely that anyone reading this would have the time, interest, or inclination to read articles of this nature (although if I'm wrong, a quick google search will take you to them).

My point is not so much to tell you what you should be reading, but to highlight what you should NOT be reading:

Virtually any mainstream financial columns or articles appearing in newspapers or magazines.

90% of such articles are useless financial prognostication and it's impossible for the layperson to discern the other 10%.

Ask your doctor what he reads to hone his diagnostic and professional skills and he will not tell you "Dr. Oz's fascinating 'fat-busting' tips in Newsweek," nor is he regularly surfing WebMD for useful tidbits.

Carefully guard what you let into your brain.  Your portfolio will thank you.

"Do not conform any longer to the pattern of this world, but be transformed by the renewing of your mind."
-- Romans 12:2 

I read a recent study of financial advisers and found that in comparison, my practice generates approximately the average "compensation per owner" based on several comparative criteria.

That is accomplished via a revenue number on the low end but a very high relative profit margin due to a very low overhead.

So, there are different ways to run a business that produce essentially the same result for the owner(s).  However, when shopping for an adviser, this subject should be of importance to you.

Why?  Several reasons.

• A low overhead allows me to price my services wherever I want.  I choose to charge less than the going rate because the going rate is too high, but also because I have the luxury to do so.  Low overhead makes this possible.  High overhead advisers fees are determined for them-- they must be high enough to support their overhead.
• Overhead represents deadly leverage during slow periods or economic downturns.  A profit margin of 80% means that an income reduction of 20% causes a profit reduction of 25%.  A profit margin of 40%  means that an income reduction of 20% causes a profit reduction of 50%.  I don't know many businesses that can withstand a 50% profit reduction for very long (aside:  couple this fact with the asset-based fee model that many financial advisers use and it's little wonder why hundreds of advisers practices were wiped out during 2008-2009).
• Staff often causes items to be delegated that should be automated or eliminated.  If you work for a company (or if you ever have), just think about how much of your job consists of conference calls, sales meetings, and administrative busy work that causes you to be less effective and causes the company to be less profitable?

I'm not suggesting that any financial adviser with a staff is burning money.  Just keep your eyes open, ask some smart questions and you'll be able to tell the difference between a fiscally responsible adviser and a house of cards (ie, Bear Stearns, Lehman Brothers, Merrill Lynch-- a good measure of how your money will be handled is whether or not the adviser can manage to keep his own business operation from imploding).

I work alone which causes me to think hard about every business activity I spend my time on.  It allows me the luxury of charging a lower fee than my competitors.  It makes me less susceptible to business downturns.

Good for me and good for you.

Related posts:

Death by conference call

The power of one