Optimism Bias

Key Takeaways

  • Humans tend to overestimate the likelihood of good events occurring and underestimate the likelihood of bad events occurring.
  • It’s good to be optimistic about your investments, the economy and your personal future, but make sure you plan for the possibility of negative events occurring.
  • Without planning for a financial or personal setback, you could face a bump in the road from which you and your family never recover.

Feeling overwhelmed by technology and the future? We’re here to help. Don’t miss our next Technology Open House on October 8.

Do you remember the 1950 movie Annie Get Your Gun with Betty Hutton and Howard Keel? It has the famous back-and-forth scene “anything you can do, I can do better.” It reminds me of a phenomenon in human behavior called “optimism bias.” About 80 percent of us have it.

Optimism bias means we tend to overestimate the likelihood of good events occurring, and we tend to underestimate the likelihood of bad events occurring. It’s just the way most of us are wired. For example, 94 percent of college professors surveyed felt their teaching skills were better than average. Likewise, about 80 percent of surveyed drivers felt they had above-average driving skills—I guess they’re not on the highway with me!

Now, before you start bashing people with optimism bias, remember that when we face negative events, we tend to be in a better state of mind than somebody who’s pessimistic by nature.

So how does this relate to money? Well, you can be optimistic about your investments, but you need to understand that reality can be negative at times. When you put your financial plan together, you look at cash flow, taxes and your balance sheet. You and your advisor should do this conservatively.

Then when you structure your investment goals, make sure you plan realistically. You can be optimistic about the future, about the markets, about the economy and your personal future, but negative events can happen in all those areas—without warning.

When reality sets in, we want to make sure our investments don’t get hammered and we don’t end up in a situation from which we cannot recover. That’s what good structure prevents.

So it’s very important to understand that most of us suffer from optimism bias. Again, four out of five of us have it. That’s OK. You just have to make sure that you plan for the real world in order to ensure that you don’t end up in a bad place.

Speaking of dealing with an uncertain world, I have a commercial here for our next annual Technology Open House coming up on October 8. It will be held from 5 to 9 p.m. right here in our offices.

For more on optimism bias, read this article or watch this TED Talk.

So until next time, enjoy.


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