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When knowledge is a dangerous thing

More informed investors do not necessarily make better decisions.
When knowledge is a dangerous thing

More knowledge can sometimes be dangerous for investors, according to new research.

“People with high financial literacy tend to take too many risks,” concludes Kansai University’s Taizo Motonishi in a new paper. He shows that more knowledgeable investors are more likely to borrow too much, to buy speculative stocks and to invest in expensive funds.

One reason for this is that it can lead to overconfidence and to what the Nobel laureate Daniel Kahneman calls “the illusion of knowledge”. Earlier research by Martin Weber and Sebastian Muller has found that sophisticated investors buy expensive, but poorly performing unit trusts because they over-estimate their ability to pick good funds. As Charlie Munger said, “it’s the strong swimmers who drown.”

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