When it comes to investing, overconfidence and ignorance are a potent mix.
A recent study polled 1,215 US retail investors to see who were most likely to buy stocks on margin (when you leverage your position by borrowing funds from your broker) and to get a margin call (when losses result in your broker demanding additional funds or closing your position).
The study assessed respondents’ investment literacy by asking them 11 questions on topics such as stocks, bonds, bankruptcy, margin and short selling, among others.
The results: less knowledgeable investors were more likely to buy stocks on margin; so were overconfident investors.
It brings to mind the Dunning-Kruger effect, a psychological bias whereby people with less ability are most likely to overestimate their ability. As psychologist David Dunning once noted, the "great menace" is "not ignorance, but the illusion of knowledge".
