Of all the behavioral finance, cognitive errors, and human psychology I have studied, the one that creates the most confusion is the Dunning-Kruger effect. Perhaps its rise in pop culture is to blame. Regardless, I find DKE to be an incredibly useful tool that helps explain many of the individual errors we see in investing.
I find it useful to think of Dunning Kruger in terms of metacognition: One’s ability to self-evaluate a particular skill set. Metacognition appears to be a discrete skill unto itself, and unsurprisingly, it increases along with the underlying skill. As you improve at a thing, your ability to evaluate your skills at that thing also increases.
Note that “Unskilled and unaware of it” is more than mere overconfidence, hubris or incompetence; it’s a very specific way to describe not just an overestimation of skills, but a way to framing that helps us understand why that error occurs, and how it manifests in human decision-making.
Yes, the least competent suffer from the Dunning-Kruger effect, but so too do those of average competency, albeit by a lesser degree. Even experts can show the effects of DKE, as their deep knowledge and awareness of difficulty may lead them to underestimate their own abilities.
Metacognition is a tricky thing.
There have been repeated attempts at debunking Dunning Kruger over the years, typically by mathematicians arguing a lack of statistical significance versus mere random noise. I remain unconvinced by those arguments, especially given that larger studies have confirmed the original underlying research.
About those experts: It is a feature of the genre that some very smart people can suffer from “deformation professionnelle” – a DKE-related tendency to view the world through the lens of one’s own profession. Hence, we should not be surprised that a mathematician looks at a psychological phenomenon and sees only the statistics.
“Does anyone know what Dunning Kruger actually is?” has a delightful recursive character – the first rule of DKE is you don’t know you are in DKE – and has a fractal-like character that mathematicians should appreciate.
The all too obvious irony of a mathematician performing statistical analysis on psychology research unaware of potential error is his psychological analysis is from whence we get our title: The first rule of Dunning Kruger club is that you do not know you are in the Dunning Kruger club…
What if Dunning Kruger Explains Everything? (February 27, 2023)
MiB: David Dunning on Metacognition (March 21, 2020)
Unskilled and unaware of it: How difficulties in recognizing one’s own incompetence lead to inflated self-assessments
Kruger, J., & Dunning, D.
Journal of Personality and Social Psychology, 1999
Yes, The Dunning-Kruger Effect Really Is Real
Rational Skeptic, April 7, 2022
The Dunning-Kruger effect revisited
Matan Mazor & Stephen M. Fleming
Research Department of Experimental Psychology, April 8, 2021
A rational model of the Dunning–Kruger effect supports insensitivity to evidence in low performers
Rachel A. Jansen, Anna N. Rafferty & Thomas L. Griffiths
Nature Human Behaviour, February 25 2021
The Dunning-Kruger Effect Isn’t What You Think
By Eric C. Gaze,
The Conversation, May 23, 2023
Math Professor Debunks the Dunning-Kruger Effect
By Eric C. Gaze
SciTechDaily, MAY 9, 2023