In memory of Dr. Andreas Höfert

Brazil and the perils of overconfidence

| Tags: Andreas Höfert

The football party is over and Lineker’s famous quip that "football is a simple game; 22 men chase a ball for 90 minutes and in the end Germany always wins" proved prescient. Pundits are now dissecting every statistic from the World Cup to find new trends or to validate old truths. Many are still scratching their heads over how Brazil was crushed 1–7 by Germany in the semifinals, and fell 0–3 to the Netherlands in the match for third place. There seems to be a lesson here that is also important for investors.

With hindsight, many experts now say that the 2014 Seleção was the worst Brazil had fielded in a World Cup. The same experts had put Brazil among their favorites before the semis debacle. So had we, but we have an excuse: We ran an econometric model based on several criteria including past performance and home advantage.

Our model estimated Brazil’s chances of winning at 30%; Argentina followed at 12%; and Spain and Germany at 9% each. Thus, the model worked well considering that three of the four teams reached the semifinals. It even ranked the Netherlands as the sixth team most likely to win it all.

It is meager consolation for Brazil that its fourth-place finish is better than its performance in 1954, 1966, 1982, 1986, 1990, 2006, and 2010. Then again, its 1–7 loss to Germany is the worst defeat the national team has ever suffered. In its wake, the Brazilian legend Pelé wrote, “I always said that football is a box of surprises.”

That has not stopped the experts from trying to explain what happened. A particularly intriguing one lays the blame on hubris – the kind that borders on magical thinking: “We just need to think hard enough that we will win, and we will.”

Readers indifferent to the beautiful game may be asking themselves, “Why should I be interested in this?” The answer is that Brazil’s loss is yet another illustration of one of the major flaws of our time: a think-positive attitude that leads to overconfidence, self-delusion and, ultimately, the illusion of control. Sound familiar?

Overconfidence may be one of the most pervasive of behavioral biases. In his Little Book on Behavioral Investing, James Montier writes how, when asked to rate their own driving skills, a vast majority of people considered themselves above average. Ask fund managers to rate their investing skills, and you are highly likely to get a similar result.

With overconfidence comes the illusion of control. Studies have found that people are willing pay four times as much for a lottery ticket if they can pick the numbers than if the numbers are randomly generated. This illusion could develop into a belief in magic. In his classic book on positive thinking, Think and Grow Rich, Napoleon Hill declared that “thoughts are things” that drive their own realization. Thinking hard about success is the key to success. If you failed, then you didn’t think hard enough about it.

Hill’s study has two obvious flaws: a selection bias (how many unsuccessful people have thought hard about success?) and the impossibility of disproving the thesis (that someone who had failed didn’t think hard enough about succeeding).

In her book Bright-Sided, a superb critique of positive thinking, Barbara Ehrenreich shows how the illusion of control has led to fiascos in medicine and politics, and how it was one of the root causes of the 2007–08 financial crisis.

Arguably, the Brazilian players entered the semis thinking they could conjure up the presence of the injured Neymar just by the power of their emotions and their indestructible will to win. Possibly, it was a lack of tactics and a strategic void that led to their home-turf defeat.

Thinking positively can inflate overconfidence such that the illusion of control takes over and overshadows rational estimation. Rather than conjuring Neymar’s magic, the Seleção might have been better off sticking to Immanuel Kant’s or René Descartes’ reason. Once Brazil was down 0-1 against Germany, it still had 80 minutes to turn-around the score. There was no need for supposedly world class defenders to start attacking without a plan, which made the Seleção look like an amateur junior team.

Reason may be less romantic than magical belief and not quite the stuff great stories are made of, but it is much more effective in football and in investment alike.