Monday, April 20, 2015

Dunning-Kruger and Other People's Money

Dunning-Kruger and Other People's Money
When it comes to other people's problems (O.P.P.), I'm always an expert. When a friend is flummoxed over a new job offer, and whether he should stay put or jump ship, I can give cogent advice on the spot. Unsure how to deal with a family issue? Ask away. I've got you covered. And when it comes to money, it's a whole 'nother ballgame. Despite having no formal training or certifications whatsoever, I'm happy to opine on all sorts of financial matters. With anyone. Strangers, even. At length.

Why should I be so confident when helping with other people's problems? For one, because we all are pretty confident in those situations. It's always easier to see the clear answer to someone else's problems. They can't see the forest for the trees, but we can. They're working under a variety of biases, and often don't realize it. But we, their trusted friends and advisors, see them clearly and can guide them to an optimal solution.

They are having a hard time selling their house because they've anchored too high, based on what they paid for it five years ago.

Or maybe your friend is falling prey to the sunk cost fallacy, and will throw good money after bad on that old clunker he still drives around.

But there's another psychological bias at play here, and it's with the jerk who's giving out advice left and right. I suffer from the Dunning-Kruger effect. (Don't worry, you do, too. See how confidently I said that?) It's a bias where an unskilled amateur overestimates his expertise in a given area. You know, like when a guy who just barely earned an English degree and has no formal training in finance writes a blog about personal finances, and somehow misses that it is rife with run on sentences.

The Dunning-Kruger effect illustrates that most people overestimate their abilities. While top performers tend to underestimate their abilities by a small amount, the majority of people end up overrating their own skills, resulting in the odd tendency for everyone to think they're above average. This unfortunately results in a sad truth: we are all confident idiots. Worst of all, the less competent we are, the more likely we are to have a crazy, contrived confidence about a subject.

Seeing how I'm usually pretty confident with all things finance, might I actually be that terrible, cocky douchebag that Dunning and Kruger are trying to warn us about?

It is bad enough that I'll tell friends and loved ones about how to budget or reduce their spending since, you know, there's a whole field of professionals out there who actually know what they're talking about. But I actually have the gall to write about this stuff anonymously, to anyone who happens to have a computer, and is unlucky enough to stumble across this little blog. (You play a role too: you're brave enough to read this stuff, and maybe foolish enough to put it into action.)

What's most interesting is how easy it is for me to try to solve other people's money problems. I really like telling a certain family member about how he shouldn't be raiding the money is his 401k to pay his income taxes, how he should be adjusting his W-4 withholdings so he doesn't end up owing five figures in federal taxes again next year, and how he really needs to be paying down all his consumer debt. I honestly feel like this is the right advice, and even feel compelled to provide it...without any invitation or solicitation whatsoever.

But why? I'm just some guy. I'm no CPA. No CFP. Sure, I read some blogs and, in relative terms, seem to be doing well with money.

The comfortable approach is to wonder if, you know, maybe I am qualified. Maybe I'm in that top 25% of people who actually underestimate their abilities. We paid off all our debt. We have some investments. And lookie here, we even have a budget in Microsoft Excel. Besides, you don't always need some fancy letters after your name to be right. Right?

And that's the crux of the Dunning-Kruger effect. It's the novice's unwarranted confidence in a subject he knows only a little about: enough to be dangerous. It turns your weekend warrior into something much worse: the modern jackass.

This points me to believe that you probably shouldn't be reading this blog. It might be time to unsubscribe, brave reader. At the very least, the blog should come with a warning.

I write because I like writing. (Kind of.) But also because I think that maybe there is something to the way we're sprinting to financial independence, and that other people might want to do the same. Maybe these words get people to improve their financial lives, or inspire them to get rid of debt like we did, or to pay off a mortgage, or to retire early. Maybe this blog helps. It's possible.

We don't give a lot of thought to the possibility that there might be some harm in there, too. What if someone retires early due to these sort of amateur financial blogs, and it ends up being a really bad decision?

So here's your warning, folks, and you only get it once. I do not know what I am doing. I am not a certified financial planner, though I play one on the internet. If you actually want to get ahead in this world, you should seek advice of a qualified professional.

Maybe I should, too.


*Photo is from Christopher Paul at Flickr Creative Commons.

35 comments:

  1. I think that anyone who reads a few personal finance books is in the 1% of financial common sense. I also think it's important to evaluate and consider what is written and then see how it could help/apply to your situation.

    But yeah your right I probably walk around like some big PF finance jerk telling everyone what to do with money when in fact I have screwed up a few times along the way.

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    1. Hey there Steven,

      I definitely didn't want to give the impression that only those who haven't screwed up should be giving financial advice.

      Only to point out that I, as a truly amateur financial blogger, might be overestimating my skills. I'm giving advice and assuming I'm knowledgeable, that the advice I'm giving is sound, etc. That might not be the case, given what we know about the Dunning-Kruger effect.

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  2. The problem is that you have a lot of "professionals" who are simply sales people and they probably know as much as the ordinary person who dedicates time to the discipline. I also believe that "the establishment" has an incentive to tell ordinary people that they are "dumb", in order to get fees motivating them to save, "manage" their money etc. Frankly, I think behavior finance is a bunch of BS, to make reasonable people doubt their abilities. I also think it is better to listen to someone who has "made it", rather than someone who tells you how to "make it" ( but hasn't actually achieved what you want to achieve themselves).

    If you spend time learning about investing, and personal finance, you will do much better than the majority of those out there. But this is similar to any other "occupation" - if you want to learn how to program code, you need 4 -5 years in school, some on the job experience, and then keeping up with developments. Now whether you choose to be a jerk about it or be really level headed - this is something entirely different. I know an engineer who is a total jackass, but I think he would be a jackass no matter what he did.

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    1. There's a lot going on in that comment!

      For what it's worth, I give a lot of credence to behavioral economics, and I definitely would not call the entire field bullshit. To each his own.

      I'll agree with you that the professionals might be salespeople first, by and large. There's no shortage of investment advisers who are simply out there to profit off of their clients' money. I still think a CFP would trounce the average DIY investor when it comes to a competition of financial knowledge, but that's likely just a result of the certification and the training that led up to it, and doesn't mean that the CFP is necessarily in his clients' corner.

      I also agree that there's something to a self-taught approach. DIY is better than ever, thanks to the internet.

      I just also think we may be subject to biases when it comes to self-evaluation.

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    2. I spend a lot of time thinking about investing and reading about it. It seems to me that the tough part in investing is just finding a strategy and sticking to it. This is where you have people who sell when prices fall, or those who switch from one strategy to the next.

      So in that sense, you are correct - I did go a little overboard calling beh fin BS.

      The thing about investing of course is that it is not exact science. In mathematics, one plus one will always be two. In investing, you can put all your money in low index funds, and still not generate a return after say 10 - 15 - 20 years. Also, past performance does not correlate with future performance. For example, the Russian stock market outperformed NYSE between 1866 - 1917, yet it wiped out shareholders after that. But when people talk about historical performance of equities, few discuss this issue.

      So i do understand why some people get scared when things get tough too. We do not know in advance what will happen and whether adding to stocks when prices are down is smart or dumb. This is where I think beh fin is BS. The thing is that investing is all about leaping into the unknown. So since you do not really know what the future is, you will make mistakes in retrospect ( no matter how much you try to prevent them).

      It is also possible that my comment is an example of the DK bias - I am so short sighted that I have failed to see how dumb I am.

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    3. I agree that there are a ton of unknowns with investing. That's also why I think indexing might be the right choice for most people: without the requisite expertise, they might be better served taking the low-cost, more diversified, and simple approach.

      The part of Dunning-Kruguer that I find most interesting is that the very top performers underestimate their skills. They know enough about a subject to also realize how huge the subject is, and how much they still have to learn. That genuine humility is a tell.

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  3. You bring up a really good point here. The issue with the internet is that you have to at least "pose" as an authority or play yourself up as an authority to get people to listen to you. Ultimately your advice could be really bad, though, and could cause others to make some seriously bad decisions. I think people typically look for blogs and "authorities" that will validate pre-conceived notions. So if I have this idea that early retirement is a good idea, I will Google until I find blogs that validate that idea. I think we do this without being conscious of it.

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    1. I love your last point, DC. People look for validation of their existing ideas (i.e. - confirmation bias).

      I heard a quote once: No one likes hearing someone else's opinion...they like hearing their own opinion expressed by someone else.

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  4. I'm always underestimating my abilities, so I'm going to confidently assume that I'm a top performer, thereby ignoring all other factors and justifying my reasoning for giving unwanted advice. ;-)

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  5. Having those initials behind your name simply means you spent the time and passed the test. It doesn't mean that sound financial principles are practiced. Even Abe Lincoln didn't have a law degree. You can become the expert through independent reading, study and practice.

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    1. That's absolutely right. You can be self-taught.

      But is someone who is self-taught necessarily any less subject to this bias? Are they less likely to underestimate their abilities?

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  6. "I am not a certified financial planner, though I play one on the internet" ha ha! I think this is why most PF bloggers have some kind of, "I'm not a financial expert" disclaimer in the fine print on their blog. I think I'm right on par with my own expectations. I don't "tell" people how to live their financial lives…I describe my own journey, and if they can learn something from it, great! If not, there are 10 million other blogs out there which will teach someone better than I can. And for me reading, I take all financial advice with a grain of salt…even from the "experts." But I love your blog anyway, so I'd keep reading even if you told me to run out and buy those Jimmy Choo shoes. :)

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    1. You should totally buy those Jimmy Choos. So cute!

      You've hit on the key point, I think, and that's when a blogger talks about what he or she does, rather than the "Top Seven Ways to Do X" or "Five Reasons You Should Be...fill in the blank".

      I think the disclaimer stating someone is not giving financial advice, while legally protecting a writer, often results in the writer actually giving advice. Which is unfortunate.

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  7. I just opened a Lending Club account based on a random PF blogger's advice. I guess I should be more wary!

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    1. Peer to peer lending is an excellent subject to self-evaluate.

      Do people really understand the subject matter well enough to invest in it? I can't answer that, of course. But it's a good example, I think, of people talking about the great returns without really being able to fully explain the investment, in some cases. Lending out money is a very tricky thing: you need to be able to properly assess the risk, and then price that risk properly.

      We can trust a third party to do those things properly, of course.

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  8. I've definitely been guilty of this. That said, if you have had success in an area and it wasn't completely by accident... Well, I think advice is okay up to a point. Especially if somebody keeps owing five figures to the IRS. Jeebus!

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    1. First, thanks so much for the tweet, Abigail!

      My family member's 5 figure tax bill was the result of him raiding his 401k to buy a 2nd home...which he then did again to pay the tax bill...cycle created.

      Still, hardly anyone could advise against that. It's too low a bar to clear.

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  9. Great article! Definitely agree that we all tend to overestimate our abilities. But blogs written by "English majors" with little formal financial experience isn't a bad thing . . . In my experience, many blogs--including yours--are awesome! I went to one of those fancy business schools where lots of people had letters after/before their names, and I think many people in the personal finance community have a better understanding of personal finance than my old classmates.

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    1. Thanks for those words, Professor!

      I'm someone who regularly suffers from imposter syndrome, so self-doubt is to be expected. In the case of writing about personal finances, it really might be warranted. ;)

      Still, Ramit wrote a fantastic article right after mine that seemed to hinge on the idea that you don't need to know everything about a field to help others: you only need to know more than the person you're helping. Credentials be damned. It's an intriguing perspective.

      The rub, of course, is that I don't know the skill level of the readers, or maybe not even my own. :) As always, doubt abounds.

      http://www.iwillteachyoutoberich.com/blog/how-i-handle-negative-critics/

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  10. I think all bloggers overestimate their abilities. That's part of the charm for me. The bar is just so very low. A few weeks back, I was reading a bunch of blogs and commenting on some of them, and I realized, "Hey, I know as much as these guys. I could start my own blog."

    However, since starting the blog, I've tried to stick to broad ideas and personal experience because I would feel bad screwing someone over. (except for my post on life insurance which I think has the best advice that nobody ever gives, and if I'm ever famous that will be the blog post that I'll have people read).

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    1. Hi Hannah. I hear you on us bloggers. A lot (most?) are amateurs.

      Some, luckily, are CFPs (Stacking Benjamins) and people with years of experience, and in some cases (MMM, ERE, Jim Collins) people have already reached the goal they're writing about.

      But the DIY aspect seems to be dominant. There's a charm to that, definitely.

      Will check out your insurance post!

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  11. I certainly don't think you've ever claimed to be an all-mighty, all-knowing finance blogger, telling other people what to do. It's always felt like a sharing of ideas, and of a personal journey towards something very important to you, which is the real appeal of your blog to me. And I think that's the key for me here - most of us are just putting our own ideas out there, and testing whether they resonate with others, or are just sharing our own personal perspective.

    There's also something self-perpetuating about writing about a topic as a way to learn more about it and grow and develop. I think there's enough bloggers out there now to help challenge and reinforce ideas, which is the wonderful thing about the PF community, and it ultimately benefits all readers.

    Being an expert is only a part of the equation anyway. Genuinely caring about the well-being of others and being open and authentic yourself can have a far better impact on people than telling them the 'right' answer. That can often be a real challenge for experts who 'know' they know what's best for you.

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    1. True, I try to avoid telling people what to do or claiming some particular expertise. However, I think at our cores, personal finance bloggers do aim at behavior change. We're putting ideas out there, but likely with some hope that it helps people change their spending/saving.

      The PF community certainly can challenge ideas out there, so the comment section acts as a 'check'.

      I'll note that most of the progress we've made financially has come from bloggers. Mr Money Mustache changed the way we spend. Jim Collins changed the way we invest.

      I think, in some ways, I'm lucky that I read the right blogs.

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  12. I'm with Hannah...that was one of the reasons why I decided to start a blog...I thought I knew just as much as the blog writers I read. Though I do also stick to topics that are not too technical like tax strategies or investing (other than encourage index investing). I agree with Even Steven also that many personal finance topics are common sense...sometimes people just need encouragement or inspiration.

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    1. Hey there, Andrew. I think you and I share a common approach with the blogs: mostly a chance to document our own approach and provide food for thought, rather than getting right down into strategies and tactics.

      I suppose a lot of the foundational topics are really common sense: like spending within your means.

      But PF bloggers get in to some really serious topics, too: whether or not to pay down mortgage debt, how you ought to invest your money, and most applicable to this blog, telling people that it'll be okay if you leave your working career in your 20's, 30's or 40's.

      The consequences of being wrong are pretty great. It points to a need to validate you're right.

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  13. I didn't expect the post to go this way, haha. We are not all idiots, some of us have financial wisdom behind our belts. Anything in a blog should be taken with a grain of salt, because it is information based off one person's perspective. At times I get more details, and less fluff from a blog than I do the NY times. Take that all of you wimpy reporters with strict bosses.

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    1. True, the landscape has changed. Mr. Money Mustache likely has a much larger influence than almost any journalist covering personal finance. And it's a legitimate way to get information.

      The idiots line was taken directly from the linked article. A little tongue in cheek, and meant to illustrate the point of Dunning-Kruger.

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  14. The most honest post we've read in ages -- maybe forever! Good for you for being upfront about it. And you've probably heard that this effect is very gender-linked. Women will tend to downplay their knowledge when they do actually know about something and men are more likely to do what you described -- not a hard and fast rule, of course, just a tendency. Of course, on the other side of things, the CFPs you mention are often no better than amateurs since they have their own sales agenda. And the investment bankers -- we really can't trust them at all! Despite decades of thinking about this stuff, in some ways we're all still in the wilderness, just trying to figure it out the best we can and make some educated guesses to minimize our risks. But it's all a series of gambles in the end. Have a great weekend!

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    1. Thanks for the kind words, Our Next Life.

      I knew this post would stir the pot, as I was taking a critical view of the PF community. By and large, we're amateurs who likely overstate our expertise. That doesn't mean we ought not write, of course.

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  15. Ha! CatMan & I often talk about the "mass movement to mediocrity." Technology has made it soooo easy to do sooo many things, that people can easily be tricked into thinking they are much more of an expert than they really are. Plus, it's really hard to distinguish the "real deal" from the people who are just blowing smoke up everyone's proverbial arse!

    Just look at writing - it used to be that if you wanted to get your written word out to the public, you pretty much had to go through a publisher. On the one hand it's totally cool that this obstacle has been removed, on the other, we're now in a place where any idiot with a computer and internet connection can do a plausible job of making themselves seem knowledgeable, when, in reality, they're anything but! There's nobody winnowing the wheat from the chaff anymore, so we're left to make those determinations for ourselves.

    I feel similarly about educational degrees - they're sooo common these days, practically everybody you meet has a master's in this that or the other. But what does any of it really mean? Not much IMHO.

    I tend to give much more credence to people who just speak honestly from their own experience rather than trying to present themselves as some sort of an "expert."

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    1. Agree with so much of what you've written here. There's a downside to the democracy of the internet. Caveat emptor has never been more important.

      I feel like degrees are fairly rare still (just over 30% of Americans over 25 have a bachelors). But I agree that it seems almost everyone I interact with has at least a bachelors. This probably says something about who I hang out with.

      Speaking honestly about your own experiences is a kind of fail safe. I love writers who do that. The hard part is understanding that we might not get the same results if we copy their approach. :)

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  16. I think as human beings, all of us are inherently sophomoric. And the internet has probably made it worse. Funny, because when I started my blog I was learning all this stuff and trekking my friends to do stuff like file a Schedule M because I promise you qualify and why don't you want a bigger tax return? They. Did. Not. Care. And they did so bluntly. Haha. So I started spewing my discoveries on the internet. There's a few situations where readers have told me over helped, but, man, I seriously hope I've never caused anything adverse. I have a disclaimer for my amateur like Tonya talked about, but I certainly hope no one ever has cause to refer to it.

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    1. *telling

      Look at me further evidencing your point! A self proclaimed writer who makes incessant spelling errors thanks to commenting via smart phone.

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  17. Great post and you sort of beat me too it... I have something similar lined up in my drafts for a while but it was more focused on other people (hah!) whereas yours is more of an introspection which is a nice angle I didn't really consider (look at me Dunning Krugering all over the shop there)

    I remember coming across the Dunning Kruger effect on Wikipedia a good few years ago and it seems to explain a lot of unjust situations in the world to me. How people much more highly paid can make such dumbass decisions for example and still think they are justified in receiving their paychecks (well I guess it's that + greed. A potent combo!) - they are constantly over estimating their expertise and genuinely believe they deserve to be cream of the crop. Meanwhile those who are genuinely talented constantly doubt themselves because they "know what they don't know", which anyone who is intelligent knows is A LOT, and therefore may end up underselling themselves and getting the raw end of the deal in terms of life rewards. Obviously you have a 3rd kind of person who is intelligent and knows it, and markets themselves well! They will end up doing better than both of the other types.

    I think I probably straddle somewhere in the middle with DK, I am self aware enough to know I am not cream of the crop but on the other hand I know I am above average on most indicators of "intelligence" that we receive throughout our lives.

    All of the above really used to p*ss me off greatly until I read about DK, then it kinda made sense and I don't get (or try not to get) too annoyed anymore when I hear people who clearly don't know what they are talking about speaking as if they are an expert on something.

    Cheers!

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