Immunize Yourself From the Disease of Special
It’s natural to think bad things won’t happen to you. This is problematic because it leads people to mentally underweight their exposure to potential external negative events versus their actual probability. Given the natural inclination to think of yourself as special and not subject to the whims of fate.
This presents itself in a variety of cognitively blinding ways. Sometimes perception is skewed and events are interpreted as being more favorable than they are. In other instances it can appear we are more in control than we are.
When the reality is events tend to be random. So while the result of a coin toss is random, the path it takes is controlled. The complexity of determining the path the coin will take keeps the outcome unpredictable.
By focusing on the path instead of the outcome we blind ourselves with an illusion of control. A real world example is the tendency for people to think they are less likely to be in an accident when they are driving. While who’s driving may be a factor in an accident, generally accidents are scenarios were events overwhelm the control of any individual participant so the driver really doesn’t matter.
Optimism bias is also reflected by the tendency to improperly evaluate others facing the same risks. People view the precautionary measures they take as forward thinking and unique assuming other people aren’t taking the same precautions. The reality is most people are probably taking the same precautionary measures they are. So they think their actions are reducing their exposure to a negative outcome. When in reality they are probably merely keeping pace with the population at large. So while the steps are prudent. Their exposure remains the same.
Overcoming Optimism Bias
One potential way to try and overcome optimism bias is to visualize potential negative events outside of your control happening. This is a theory with deep historical roots in many belief systems. Picturing negative external events happening can better prepare you to deal with the possibility they may occur.
This can be a powerful tool to confront the disease of special. The mere act of thinking about something can bring it forward in your conscious attention versus being vaguely aware of something and understanding it could happen to you. But assuming it won’t due to optimism bias.
This is backed up by research. When people have prior experience with a poor outcome, optimism bias is reduced going forward when the same poor outcome is a possibility. Because they can now more easily picture the event happening to them.
This explains the reluctance of my grandparents, who lived through the great depression, to ever take on debt. Taking on debt is an inherently optimistic proposition because you expect to pay it back in the future. People often take on too much debt by over estimating their future economic prospects and subsequently can’t make the needed repayments.
My grandparents had first-hand experience seeing people lose their homes and farms because they couldn’t repay their debts. This experience helped them overcome optimism bias in their decision making because they saw the negative impact too much debt could have on people’s lives.
Optimism Bias in the Face of Infrequent Decisions
Optimism bias can be especially challenging to over-come for infrequent decisions because the less frequently we make a decision the less frame of reference we have to make it successfully. It also means we are prone to small sample size errors as oftentimes the decisions are influenced by anecdotes we hear from others. This explains why people in aggregate are under insured.
For example people who lose a parent young buy more life insurance because they have been directly confronted by the possibility of needing it. Whereas people who have not had this experience are less likely to buy life insurance and if they do they probably will not buy as much. So if possible try to find numbers to support decision making instead of relying on experiences.
Numbers cut through our natural tendency to rely on representativeness when making decisions. The tendency when faced with a decision to try and fit it into something we are already familiar with. In deciding on whether to purchase life insurance we might think oh the numbers don’t apply to us because we are unique and don’t know anyone who’s ever needed it. When we should be thinking what are the chances I’ll ever need this and what should I be willing to pay given this chance.
And while the chance you’ll need life insurance is random and unpredictable. Across a wide enough sample of people similar to you a reasonable estimate can be made of the number of people that will need the insurance. This number is what should inform your decision making rather than personal experience.
Improperly Evaluating Risks
People are also prone to viewing the lens of past decisions in a self-serving way. So if a financial goal was achieved in the past it’s because of diligent effort. When a goal has not been achieved it is blamed on external factors.
An example is spending in the present based on future anticipated income. If the money comes through then it is a result of expert planning. If it doesn’t it is due to circumstances outside our control.
This happened to me when I purchased an automobile expecting to pay it off with a bonus down the line. Of course it wasn’t my fault I purchased an automobile without actually having the money. It was the economy’s fault for taking an unanticipated downturn that I couldn’t have possibly forecast that resulted in a lower bonus than expected.
It’s also a good example of representativeness at work. Since previous bonuses would have allowed me to pay off the car I made a decision based on my personal frame reference. Which was based on the small sample size of my previous bonuses. Those bonuses were contextual to the larger economic environment and its impact on my employer though. Risk factors outside of my control that should have been accounted for when making such a large purchase.
He's published three books. Most recently The World After Covid 19: Coexisting with the Novel Coronavirus.
His musings can be found at stevenlmiller.me. Subscribe to The Pompatus Times for updates.
The CFA designation is globally recognized and attests to a charterholder’s success in a rigorous and comprehensive study program in the field of investment management and research analysis.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.