Key takeaways
In the world of property investment, a troubling phenomenon often rears its head: the Dunning-Kruger Effect.
You see.. when it comes to money, seemingly rational people don’t always act rationally. We are subject to cognitive biases.
The Dunning-Kruger Effect states that people who know very little about something often think they know more than they do, while experts are more aware of what they don’t know.
There are four main stages of the Dunning-Kruger Effect, and I must admit I have experienced all four stages in the early years of my investment journey.
In the world of property investment, a troubling phenomenon often rears its head: the Dunning-Kruger Effect.
You see.. when it comes to money, seemingly rational people don’t always act rationally. We are subject to cognitive biases.
Let me explain…
In 1999, psychologists David Dunning and Justin Kruger published research finding that people with limited knowledge or skills in a particular area tend to overestimate their abilities, while experts often underestimate their competence.
To put it simply, the Dunning-Kruger Effect means that people who know very little about something often think they know more than they do, while experts are more aware of what they don’t know.
This was particularly obvious during the property boom of 2020-21, when low interest rates created a once-in-a-generation boom that meant almost every property increased in value substantially.
Unfortunately, this made many novice property investors think they were smarter than they really were and created a whole new world of so-called property “experts”.
There are four main stages of the Dunning-Kruger Effect, and I must admit I have experienced all four stages in the early years of my investment journey.
Source of image: Tapan Desai
1. The Peak of Mt. Stupid: Overestimating Knowledge
The Dunning-Kruger Effect is vividly illustrated in the concept of the "Peak of Mt. Stupid."
This peak represents the point at which individuals, having acquired a superficial understanding of a subject, become excessively confident in their knowledge.
For beginning property investors, this often occurs after they learn a few fundamental concepts and witness early success in a rising market.
As I said, during the recent property boom, many new investors experienced significant gains with minimal effort.
The market conditions—characterised by soaring property prices and low interest rates—created an illusion of skill where, in reality, luck and timing played major roles.
These initial wins fuelled overconfidence, leading many to believe they had mastered property investment.
To be honest, my first forays into property investment were wildly successful because of booming inflation, and I believed property investment was easy and anyone could be successful.
I was oblivious to my incompetence and was clearly standing at the peak of Mt Stupid.
The Emergence of Unqualified Gurus
Today, the issue is compounded by social media platforms that have enabled a proliferation of self-proclaimed property “experts.”
These individuals, often with only a few successful deals under their belts, quickly pivot to offering advice and coaching services.
They establish a presence on platforms like TikTok, YouTube, and Instagram, attracting followers eager for guidance.
However, these “gurus” are often still at the Peak of Mt. Stupid, dispensing advice without a comprehensive understanding of market complexities.
Their followers, drawn in by the promise of easy money, are frequently unaware that the advice they are receiving is based on a limited and potentially flawed perspective.
This dynamic perpetuates a cycle of overconfidence and poor decision-making among novice investors.
2. The Valley of Despair: Facing Harsh Realities
As market conditions change, the fragility of these overconfident strategies becomes evident.
Property prices may fall (as they did in 2022), interest rates may rise as they have over the last few years), and the market can shift in unexpected ways.
When this happens, many investors find themselves unprepared for the challenges they face.
This descent from the Peak of Mt. Stupid into the "Valley of Despair" is a critical phase in the learning journey.
In the Valley of Despair, investors experience a crisis of confidence.
Their early successes no longer seem indicative of their abilities, and they become acutely aware of how much they don’t know.
This stage is marked by confusion and a sense of failure, as they struggle to understand why their strategies are no longer working.
My Valley of Despair came when, after the booming property market of the late 1980s interest rates rose to over 15%, my cash load dried up, and I learned some hard lessons about the nature of property cycles.
3. Climbing the Slope of Enlightenment
For those who persist, the journey continues with the climb up the "Slope of Enlightenment."
This phase involves a more realistic appraisal of one's knowledge and capabilities.
Investors start to seek out more comprehensive education, learning from their mistakes and gaining a deeper understanding of the market's intricacies.
They begin to appreciate the importance of factors such as strategic planning, having a financial buffer in place to ride the ups and downs of the property cycle, and doing proper due diligence and risk management.
Climbing the Slope of Enlightenment requires humility and a willingness to admit past errors.
It also involves recognising the value of expert advice from seasoned professionals who have weathered multiple market cycles.
Investors who embrace this mindset can gradually build a solid foundation of knowledge and skills.
4. Reaching the Plateau of Sustainability
Ultimately, the goal is to reach the "Plateau of Sustainability."
At this stage, investors have a well-rounded understanding of the economy and how property investment works.
They know that while they may not have all the answers, they possess a sufficient grasp of the fundamentals to make informed decisions. Their confidence is based on competence, not overestimation.
On the Plateau of Sustainability, investors are better equipped to navigate market fluctuations.
They understand that property investment is a game of finance with some houses thrown in the middle. They understand the intricacies of correct ownership structures and the importance of a diversified portfolio, prudent financial management, and staying informed about economic trends.
They also recognise that property investment is an ongoing learning process, and they remain open to new information and strategies.
Property investment is inherently multifaceted. Simple strategies might yield results in a booming market, but as conditions evolve, so too must the approaches.
Investors must be wary of the temptation to oversimplify these complexities.
While it’s possible to achieve success with straightforward buy-and-hold strategies, more advanced investments require a deeper knowledge base.
Recognising the limits of one’s expertise and seeking professional advice can mitigate risks and enhance long-term success.
As my knowledge increased, I became involved in medium-density property development, which is one of the main ways I have consistently outperformed the markets.
Some Final Thoughts
The Dunning-Kruger Effect serves as a cautionary tale for property investors.
Overconfidence, particularly when fuelled by a booming market, can lead to significant financial setbacks.
The market downturn of 2022 and the long period of high and rising interest rates were a sobering reminder of this reality, shaking many investors from the Peak of Mt. Stupid and forcing them to confront the limits of their knowledge.
To thrive in property investment, it is essential to approach the field with a mindset of continuous learning and humility.
By acknowledging the complexities of the market and seeking out reliable expertise, rather than taking advice from the new breed of so-called experts who last year were flipping burgers at McDonalds and this year are flipping properties, investors can navigate the journey from naive confidence to sustainable competence.
The path may be challenging, but the rewards of informed, strategic investing are well worth the effort.
In summary, property investment is not immune to the psychological traps that affect all fields.
The Dunning-Kruger Effect is a powerful reminder that success requires more than just confidence—it demands a commitment to learning and growth.
So, if you’re embarking on your property investment journey, tread carefully, seek wisdom from seasoned professionals, and remain open to the lessons that each experience brings.
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