It is important to understand the distinction between an investor’s objective knowledge – what they know, versus their subjective knowledge – what they think they know.
Financial capability, in the context of "how capable a person is of making an appropriate financial decision”, is critical for investors and those helping investors plan for the future. Taking a person’s knowledge and understanding on face value could lead investors to make inappropriate financial decisions. Suitable Strategies financial personality tool Bambooing, tests understanding and knowledge by exploring a person’s subjective and objective knowledge.
The objective knowledge / subjective knowledge distinction is important since in risk decisions where subjective knowledge is much higher than objective knowledge people tend to choose risky options when they shouldn’t. Conversely, where subjective knowledge is much lower than objective knowledge people tend to reject a risky option when they should choose it. In addition, people that are overconfident i.e. those with subjective knowledge greater than their objective knowledge, are:
- Less likely to seek out relevant financial information when they should since they think they already know what they need to know.
- More likely to accept and reject financial options inappropriately based on self-beliefs about being financially savvy when, in fact, they are not.
- Are less likely to seek advice from financial advisers and other experts when making key financial decisions since they think they already have the relevant knowledge and experience.
There are reasons to expect that differences between objective knowledge and subjective knowledge will be greater in financial domains because research shows bigger differencesfor:
- Non-product domains e.g. financial services, than product domains e.g. CD players. For the latter consumers can more easily develop knowledge through search and usage.
- ‘Experience’ goods such as financial services that must be purchased and consumed before people learn about quality and product attributes as compared with ‘search goods’ such a consumerdurables that can be evaluated prior to purchase and consumption.
- ‘Utilitarian’ e.g. practical products such as those offered by financial organisations, as compared ‘hedonic’ (fun) products such as cameras and iPads which are inherently more involving so people are motivated to explore product information.
Self-perceptions are often biased, leading to overconfidence - individuals see themselves more positively than they should in a broad range of situations. For example, most people see themselves as above average drivers, more likely to experience good things and less likely to experience bad things as compared with the average person, more likely to be healthy than the average person and having more control over events in their world than is actually the case.