How good is your financial knowledge? Would you say, for example, that a 15-year mortgage typically requires higher monthly payments than a 30-year one but that, generally, you pay less interest over the whole life of that mortgage? 
OK, in terms of classic trivia questions, it is not ‘After what sort of animal are the Canary Islands named?’ or ‘From where do Panama hats originate?’ but still – true or false?
Well done if you answered ‘true’ – and indeed ‘dogs’ and ‘Ecuador’ – but, either way, now that we have warmed you up, take a look at the following financial phrases and indicate, on a scale of one to 10, how familiar you are with each of them – a) Tax bracket; b) Revolving credit; c) Whole-life insurance; d) Pre-rated stocks; e) Fixed-rate deduction; and f) Annualised credit.
How did you do? If you started strongly but then tailed off in the second half, do not be too hard on yourself. Much like our two trivia questions, there was an element of misdirection – only this time with a higher purpose.
For the latter three phrases are all bogus – made up by the psychologists Stav Atir, Emily Rosenzweig and David Dunning in the course of their studies into ‘self-perceived knowledge’.
Put simply, this is not what people know but what people think they know. We’ve noted in the past, for example, we noted the well-known psychological study undertaken in Sweden in the early1980s that found more than three-quarters of participants rated themselves in the top 50 per cent of all drivers for both skill and safety.
Generally speaking, people know much less than they think do in a variety of situations and such behaviour is not confined to overestimating the extent of abilities such as driving. People will often claim to be aware of things they could not possibly know about for the simple reason that – as in the cases of phrases d) to f) above – they do not exist.
This is known as ‘overclaiming’ and, in When knowledge knows no bounds, Atir and her colleagues highlight various examples, including a study where a fifth of US consumers claimed familiarity with products that did not exist.
The paper also notes a correlation between self-perceived expertise and feelings of certainty when answering tough questions – though not with answering them correctly.
What Atir and the others did was test people’s financial knowledge on three levels – whether they perceived themselves as knowledgeable about finance; whether they really were knowledgeable about finance; and whether they overclaimed.
Interestingly, they found that 93 per cent of participants claimed at least some familiarity with at least one of the three bogus financial phrases.
More striking still were the impacts of actual knowledge and self-perceived knowledge on the extent to which people claimed familiarity with one or more of those phrases.
The more people knew about finance, the more they rated the false phrases as existing but, as a factor, the more they thought they knew about finance had twice as much impact compared with their actual knowledge.
The moral of the story is – be careful with anyone who claims any financial expertise as they may think they know more than they actually do.
It is essentially irrelevant whether they do this to preserve their image in their own eyes or perhaps in other people’s – we once met a head of sales at a well-known investment bank who coached his team it looked bad if they said ‘I don’t know’ more than twice in a meeting so the third time they should lie.
Just play safe and ask for their views on ‘pre-rated stocks’...
Ian Kelly (pictured on page 1) is co-manager of the Schroder ISF Global Dividend Maximiser fund and writes on The Value Perspective. The views expressed above are his own and should not be taken as investment advice.