Most of us aspire to think well about about our future. We strive to believe in ourselves and our abilities. We set goals and methods to achieve them. This attribute helps us to live confidently and to take risks that are good for us, but that we might not have taken if not for Optimism Bias.
What is Optimism Bias and who has it? It’s self describing: We overestimate the likelihood of positive events. But also…we underestimate the likelihood of negative events.
Here‘s a neat, if somewhat wonky, TED Talk on Optimism Bias, that asserts that our brains are actually wired towards Optimism Bias.
While this bias helps us to operate from a place of confidence, it can also serve to sabotage us.
How might Optimism Bias sabotage our financial future?
Let’s start with lifespan. How long do you think you will live? If you think you will live until, say, 95, are your savings and current lifestyle tracking to that? Is your current savings rate aligned to that assumption? Or are you thinking things will ‘fall into place’ sometime in the future?
This is also known as Longevity Risk. Which is the risk of running out of money before you die.
Now let’s look at your health. How healthy do you think your future self will be? Are you assuming you will avoid major health related issues? How would you take care of yourself if that assumption proved false? I suspect that you, like most of us, are partially in denial about what may happen to your health in the future. Yet it’s inevitable that as we age, especially if we experience advanced age, that health will significantly decline.
Oh yes, Optimism Bias, very bad in the world of your financial life!
Crazy will happen to your future self. It’s not just a likelihood, it’s inevitable. Not if, but when.
So, what to do? 2 things:
1) Save and invest for it.
2) Insure against it.
Have a Financial Plan in place that considers Optimism Bias and utilizes point #1 and point #2 for it.
The Crazy that happens may not be as financially significant as planned for, but you will be ready for it if it is. And not having to worry about the financial impact of it on your life? It will allow you to focus on the parts of it that matter: Getting on the other side of it.
What to do? Own your Optimism Bias, but don’t deny the consequences of not planning for it.