The illusion of control bias

The illusion of control bias, another form of dissonant behavior, describes the tendency of human beings to believe that they can control or at least influence outcomes when, in fact, they cannot.

For example, let’s say you decide to purchase a lottery ticket.  Which option makes you feel better about your chances to win:

1. A ticket where you get to choose the numbers?
2. A ticket with randomly generated numbers?

Rationally, you know that each ticket has the exact same chance of winning, but if you are human, you probably prefer the one with your birthday, your high school jersey number, your shoe size, and your lucky number.  You don’t have any more control by picking these numbers, but you may feel at least a slight boost in confidence.  For the lottery it doesn’t really matter which method you choose as it has no impact on the ultimate outcome.  But in investing, this can be a very dangerous bias.

So how can this bias impact investors?

According to Michael M. Pompian, author of Behavioral Finance and Wealth Management “the effects of Illusion of control Bias can have harmful effects for investors as seen below.”

1. Illusion of control bias can lead investors to trade more than is prudent. Researchers have found that traders, especially online traders, believe themselves to possess more control over the outcomes of their investments than they actually do. An excess of trading results, in the end, in decreased returns.
2. Illusions of control can lead investors to maintain underdiversified portfolios. Researchers have found that investors hold concentrated positions because they gravitate toward companies over whose fate they feel some amount of control. That control proves illusory, however, and the lack of diversification hurts the investors’ portfolios.
3. Illusion of control bias can cause investors to use limit orders and other such techniques in order to experience a false sense of control over their investments. In fact, the use of these mechanisms can often lead to an overlooked opportunity or, worse, a detrimental, unnecessary purchase based on the occurrence of an arbitrary price.
4. Illusion of control bias contributes, in general, to investor overconfidence. In particular, investors who have been successful in business or other professional pursuits believe that they should also be successful in the investment realm. What they find is that they may have had the ability to shape outcomes in their vocation, but investments are a different matter altogether.

Let us help you eliminate this bias.  Professional advisors with disciplined systems of investing tailored specifically to your investment goals will allow you to overcome many of the obstacles inherent in our very nature.  At DWAM, we can help.