Not That We’d Brag

MANY OF THE WORLD’S religions view humility as an admirable trait to which we should all aspire. It’s frequently associated with poverty, as practiced by devout orders like Buddhist monks and the Sisters of Mercy. But when it comes to investing, humility can—ironically—make you significantly wealthier.

As documented by the behavioral finance research, overconfidence can lead to worse investment returns when investors presume, without justification, that they’re skilled at, say, picking market-beating stocks. The research on indexing versus active stock fund management overwhelmingly shows that, for long holding periods, actively managed funds perform worse than index funds, on average. That doesn’t mean active management never succeeds, but the odds are heavily stacked against those who try.

The superior return history of indexing can strike folks as counterintuitive. It seems as though investors are just settling for average. But research shows that investors who choose low-cost indexing can end up with fund results that outpace 80% or 90% of active managers.

In addition to feeling counterintuitive, indexing flies in the face of our inherent belief in our own abilities. In opting for index funds, it can feel like we’re surrendering to the poverty of a religious order by not aiming to outperform. But in fact, it does just the opposite, making investors on average wealthier than if they’d pursued active strategies. Want to avoid the negative financial consequences of overconfidence? Let humility be your antidote.