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Thinking you’re smart is risky

By Jennie L. Phipps · Bankrate.com
Monday, November 8, 2010
Posted: 3 pm ET

If your retirement planning includes managing your own investments after you stop working, here's some counterintuitive advice from a professor at the University of Iowa, who has been studying the investment learning curve. Yiming Qian, an associate professor of finance in the Tippie College of Business, examined the trades of 31,000 individual investors and discovered that people who have investment success early on are likely to be overconfident and have poor results for a while before they finally master the craft of investing.

She said the trend  is a result of what is called naive reinforcement learning, where people who make money on their first trade believe their success was due to their own investment skills and not to outside forces. Confusing luck with ability and armed with a false sense of confidence, these investors continue buying stocks, only to see their returns dwindle. On average, it takes 24 trades, Qian says, before individual investors catch on and their earnings per trade start rising again.

Her advice for investors who can't afford to lose much of their retirement money is humility -- and caution. "If you have had good investment returns in the past, think twice before you attribute that to your stock-picking abilities," she says. "Don't let it encourage you to become more aggressive in future investments."

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