The internet makes you a worse investor

Financial literacy levels have been miserably low for years, of course, so this need is nothing new. Yet our collective financial literacy seems to face a new and very modern threat: the Internet.

According to a study published this summer on the Social Science Research Network (SSRN), the Internet tricks investors into thinking they know more than they actually know, and the resulting overconfidence leads to its poorer performance of their portfolios. I first heard about this fascinating research from the ever insightful Joachim Klement, Trustee of the CFA Institute Research Foundation and former Head of Equity Strategy for UBS Wealth Management.

The SSRN study, titled “Confidence Without Competence: Online Financial Search and Consumer Financial Decision-Making,” was conducted by Adrian Ward, professor of marketing at the University of Texas at Austin; Tito Grillo, professor of marketing, business economics and law at the University of Alberta, and Philip Fernbach, professor of marketing at the University of Colorado at Boulder.

The study reached its provocative conclusion in several steps:

• Researchers have shown that using the Internet to answer questions leads people to take credit for the knowledge they obtained from the Internet instead. Indeed, after having used the Internet to search for information, people will forget afterwards that they have done so. This phenomenon is sometimes called the Google effect – the blurring of boundaries between internal and external knowledge that leads “people to think they know more than they actually know”.

• The researchers then showed that the Google effect leads investors to be overconfident. They demonstrated this by dividing a sample of investors into two otherwise identical groups based on whether or not they had internet access during an investment knowledge test, and then giving each group the same investment challenge. . After investors built their portfolios, they were asked how much money they would bet on the subsequent performance of their portfolios. Unsurprisingly, the group that had Internet access performed better on their exams than those that did not. And this group with the highest scores also bet more, on average, on the performance of their investment choices, indicating greater confidence in their investment abilities.

• The overconfidence of this highest-scoring group, however, was misplaced. On average, according to the researchers, investors in this group achieved significantly lower returns than those in the other group. This phenomenon is the “trust without competence” to which the researchers refer in the title of their study. The source of the lower performance of the group with the highest scores appears to be their greater willingness to take risks.

This new study recalls the dangers of overconfidence and the virtues of humility. But what I found most significant about the research — and most disturbing — is the pernicious way the internet tricks us into increasing our self-confidence without us even knowing it’s doing it. So even those of us who try to resist the dangers of overconfidence can still be led down the path of primrose.

This consequence of the Internet is not an accident. Sergey Brin, co-founder of Google, said at a Google event in 2010 that “We want Google to be the third half of your brain.” The authors of this recent study interpret this statement to mean that Google is blurring “the lines between the knowledge that resides in the head and the knowledge that resides on the Internet”.

Investor beware.

Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at mark@hulbertratings.com.