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Holistic Financial Wellness Principles: Principle #6 – Optimism Bias

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For this, my final essay on the principles of Holistic Financial Wellness, I need to disclose some aspects of my life that in normal circumstances I would never consider writing about and posting where strangers can read. I do so, however, because throughout Money Mountaineering and in the previous 5 essays, I have not shied away from sharing aspects of my life that bear directly on the issues I am discussing. To not do this now, would be the height of hypocrisy.

HFW #6 is all about our irrationality and the blind spots we all have when it comes to making important financial decisions. It advises you to strive for “fearless self-awareness” and to take note of our limitations when we consider our own situations and the areas where we may need help. So today I want to walk my talk and share one of my blind spots that has disrupted my financial life, and unfortunately was not explicitly addressed in Money Mountaineering.

In What’s Your Future Worth? and in Money Mountaineering, I have expressed my view that predicting the future is impossible, but imagining it is not. In fact, my recent essay about HFW#4 addresses this directly by noting how important it is not to anticipate what the future will hold, but instead we try to imagine what might happen and then prepare for it. In my most recent essay on HFW #5 I counseled that you follow my father’s advice and “hope for the best but prepare for the worst”.

And while I have generally been able to adhere to the 6 principles I espouse, my financial life was recently upended by one of the most important financial contingencies out there that affects several hundred thousand of us every year and millions overall. In retrospect, I wish I would have included at least a brief discussion of it in Money Mountaineering, but for reasons that will soon be apparent, I didn’t.This essay is my attempt to rectify that omission, while at the same time expanding on the notion of what I mean when I say that financial wellness requires that we “acknowledge our cognitive and emotional limitations as human beings”.

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Optimism Bias and a Failure of Imagination

In Chapter 11 of Money Mountaineering, I describe what I consider to be the most important emotional biases and cognitive errors that we can fall prey to when we make financial decisions. In preparation for writing Money Mountaineering, I reviewed much of the Behavioral Economics literature and discovered that in the years since I had been immersed in the subject, many more “system bugs” in our make up had been discovered and explored. To make the book as useful as possible, I decided to focus on what I considered to be the most important and “dangerous” aspects of our “programming errors” that can prevent you from making good financial decisions.

In the book I describe 8 emotional biases and 7 systematic cognitive errors that we are all prone to, but I left out one emotional bias that not only is important but is also one that I recently fell prey to in my own life. Ironically enough it was probably this bias itself that caused me not to explicitly address it anywhere in the book, and it is one which I want to talk about now. Specifically, I am referring to what is called “Optimism Bias”.

Optimism bias is a bias that “causes someone to believe that they themselves are less likely (vs what the actual probabilities are) to experience a negative event” (see for example https://en.wikipedia.org/wiki/Optimism_bias). While this bias has been observed by psychologists since the 1980s, systematic analysis of this bias only began in the last 20 years (see for example http://www.crossingdialogues.com/Ms-A14-09.pdf).

I doubt that adding one more bias to my Chapter 11 catalogue of our emotional biases and cognitive errors would have made for better reading, but still, I regret not discussing it – especially because the financial consequences of optimism bias can be significant.

Right now, I am suffering the consequences of what can happen if you ignore the full range of unpleasant ways a decision might turn out. Fundamentally, I experienced a failure of imagination and I want to talk now about how it happened.

Time Traveling and Imagining a Painful Future

In the last chapter of my first book What’s Your Future Worth? I describe the first conversation I had with my wife about our respective personal balance sheets. It happened on our very first date as we were getting to know each other, both of us very much realizing that we liked each other very much. We disclosed our financial situations to each other — my significant accumulated assets and her bright red ledger full of student debt accumulated in pursuit of her Ph.D.  I had no doubt in my mind that pursuing her was the right thing to do, and in the book, I describe my thought process (clouded by emotional biases of all sorts as it undoubtedly was).

That initial conversation took place in 1995, and the next time we addressed the subject was shortly before we got married at the end of 1998.

In that second conversation a few months before our wedding date, my bride-to-be asked me whether I was going to ask her to sign a pre-nuptial agreement to deal with the wildly different financial situations we were bringing to the marriage.

This question was, in one sense, not about money, but in another sense, it was only about the money. In fact, it was a very specific question about what would happen to our money during the marriage, and more importantly – what would happen to our money if our marriage did not survive.

It was not as if I hadn’t thought about the question. I had. In fact, I had thought very deeply about it and when my fiancé asked the question, I was not the least bit surprised.

Before I tell you how I answered her, I need to first acknowledge what many of you already know, but perhaps some of you don’t. My wife and I separated at the end of March 2020 shortly after COVID locked us down together in our house in Berkeley. I moved out to live full time at our farm in Santa Rosa, and that is where I live now.

We are currently in the process of working through the excruciating details of a legal divorce that I hope will end soon. As I say, Divorce is a financially significant life contingency that affects many hundreds of thousands of married couples every year. And that is in normal years when there are no wars or pandemics – events that seem to bring some families closer and blow others apart. For example, right after World War II the divorce rate in the US was dramatically higher than it was in 1955, just a few years later when my parents got married (3.7 per 1000 people in 1947 vs 2.3 per 1000 in 1955) My parents recently celebrated their 66th wedding anniversary, but I won’t — even though the annual divorce rate throughout most of my marriage has “only” been between 3.5 and 4 per 1000 each year (https://divorcescience.org/2013/03/12/us-divorce-rate-2001-2011/).

Part of the issue is just pure math. Note that over a 20-year marriage even a 3.5% annual divorce rate means that you will have less than a 50-50 chance of emerging from two decades still together. This was a fact that I was well aware of when I got married, but I did not let that dissuade me. For me, the risk was far, far outweighed by other non-financial considerations, and if you read What’s Your Future Worth? you will understand why.

I think there are two main reasons that I am in my current situation. The first and obvious reason is that I simply fell prey to optimism bias. The fact is, I just didn’t believe it would happen to us. It’s not like I shouldn’t have known better.  As I said, the data told a pretty clear story. But the problem with average data is that we all like to believe we are not average. In fact, we aren’t, but averages do matter, and our emotional biases very often steer us to ignore the odds that we can use to make better decisions.

Actuaries are people too, and I was not immune to the perils I outline in Chapter 11. I was convinced I knew better, and even though I periodically visited actuarial websites where an algorithm would calculate my actual individualized odds (always telling me I was a heavy favorite to get divorced), I simply would find reasons for their being wrong. Finally admitting defeat was not easy. Especially when my optimism bias made it so much harder to realize that my marriage was finally over. 

Had I realized what was happening at the time I might have written about it, but had I done so, I wouldn’t have written it in the way I would now. I understand the nature of the financial risk divorce poses much better now and it is a very complicated one, particularly with respect to the timelines and unexpected financial surprises (mostly bad) that inevitably arise when two human beings decide to end their marriage. We are not rational creatures, and I guess that is why we have lawyers to help us sort things out.

That being said, there was a time when I was thinking pretty rationally, and that was before the marriage. When my fiancé and I sat down to discuss the pre-nup, I had done my work on considering as many scenarios as I could imagine, but almost all of them involved enduring some very painful Time Traveling, and while I did do my due diligence and took steps to prepare for the contingency, it was not an exercise I enjoyed or did particularly well.

The fact of the matter is that not only is every individual’s probability of getting divorced a function of many variables – some known, like age and duration of marriage, but there are many others that are unknown and often random. And not just random, many are random events that come from an unknown distribution which we can never discern.

One thing I did do, and you can do as well – in addressing this as well as all the other life contingencies that you don’t want to think about — is to ask yourself a lot of “what if” questions and then try to inhabit your future self. When you get there, look at the possible financial situation you will find yourself in, and try to imagine how you will feel under each one. It’s painful work, but it can help you make better financial decisions.

These days, when I am often tempted to kick myself for making a bonehead decision, I remember Annie Duke’s counsel against “resulting” – i.e., thinking you made a mistake just because your decision turned out badly. I still feel like I did the right thing, it just didn’t turn out as I had hoped.

For obvious reasons—both legal and ethical, I won’t disclose any more of the details of my divorce. I will, however, tell you the rest of the conversation my wife and I had before we got married – at least I will tell you my memory of my side of the conversation. I do so, because one of the first decisions you might have to make before you get married and before you must decide whether to say “I do” to whoever is empowered to witness your contract, is to decide whether or not to have a pre-nup.

As you may have come to realize – I don’t like to give advice. Instead, I’d rather simply tell you what I did and why I did it.

My fiancé asked me whether I was going to ask her to sign a pre-nup before we got married and I said no. I said I thought that California Divorce law was perfectly reasonable – whatever assets each party brings to the marriage is separate property and only the assets that we would acquire as a couple would be split 50-50. For me that was fair, and I didn’t see any need to make it any more complicated than that.

I still believe it was a reasonable decision and I would make the same decision today if I was faced with that choice. However, I now know, and I want you to know that I materially underestimated how complicated (and painful) ending a long-term marriage like ours could be – but that is another story that is yet to be written.

This is the last essay that will be posted before Money Mountaineering is published in a few days, and I want to sign off on a more optimistic note, because even though I have not been immunized against optimism bias, I am fundamentally an optimistic person even though I act with more than a little caution about the extreme risks, both financial and otherwise, that lurk in the wilderness in which we live. It is reflected in how I manage my financial life, and I am sure it affects the lens through which I consider financial decisions.

And so, the last message I want to give you about Money Mountaineering is this. I hope that my book will help you see some things about your money that you hadn’t, but I also want you to do your due diligence on me. As I say, I try not to advise anyone on what I think they should do, but instead will tell you what I do and why. In the end you are the expert on your own financial decisions and the only one who can ultimately make them.

I hope you choose to read about my ideas, and you find them helpful.

Happy trails,

Pete

Holistic Financial Wellness Principles: Principle #4 – Fear is the Enemy of Curiosity

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As I started to write about the 4th fundamental principle of Holistic Financial Wellness, I realized that while many of the 6 HFW principles I espouse are more and less applicable in our lives at different times, the need to be able to live comfortably with uncertainty as you make financial decisions that have  significant consequences for your future while also entailing painful costs in the present may be, for many, many people, the most important principle of all right now.

I considered lots of stories and lots of different aspects of making decisions under uncertainty to illustrate what I wrote in Section III of Money Mountaineering, but in the end I decided to address the “elephant in the room” and talk about the two parts of our human nature that can hijack our judgment and ability to make good financial decisions when the stakes are significant and the outcomes are multiple and highly uncertain.

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Hustling Chess, Overcoming Fear and Getting Curious

A few weeks ago, I went to New York City where I visited one of my favorite spots – the park at the south end of Union Square where the chess hustlers make their living charging nominal fees for lessons to those who appreciate their skills and winning money over the board from those who don’t. When I lived in Westchester and worked in NYC in the 1990’s I spent many hours getting to know these unusual characters and was able to learn a few traps and tactics that let me scare a few masters in the weekend tournaments I used to play in during my time in the City.

One of my favorite denizens of that world is a man named “Po” — a wise, funny and fast talking player of near International Master strength who never lets his customers know quite how strong he is. Po has beaten almost all of the current generation of young grandmasters, catching them as prodigies on the way up (e.g. Hikura Nakamura, Irina Krush and many others). To hear him tell it, his “lessons” helped a few future stars learn some practical tricks that fueled their rise to the top.

Like many great chess players, Po has a distinct world view and a well-articulated philosophy on how to survive on the chess board and in life. When I asked him what he thought of the current state of the world and what he suggested people do amidst all the confusion and chaos that seems to surround us, he paused and then gave me some wisdom that he passes on to both his friends and his customers. He said that the important thing was to not be afraid – not of your opponent or the all the unseen threats that might lurk on the board. He thought that most people are suffering now because “they opened their eyes and found that it is still too dark to see”.

For me, not only is that great advice, but it highlights perhaps the greatest challenge we face in living with “not knowing” and making good financial decisions despite all the uncertainty of the future and the incomplete information we have about the present.

Decisions over the chessboard are often not that different than the financial decisions I speak about in Money Mountaineering. Both entail making choices whose long term (and even short term) consequences are often impossible to predict and not even a grandmaster will be able to understand all of the aspects of a given position, let alone the plans and strategies hidden within the mind of the opponent sitting across the board. Curiosity and an ability to be openminded enough to consider many possible futures at one time is critical to becoming a good player.

For financial decisions this is even more important. Fear is the enemy of curiosity, and curiosity is what will allow you to identify the important things you can figure out and those that you can only make educated guesses about. It will help you identify the areas where a financial expert can explain aspects of your decision that you need to understand and will allow you to absorb the information that the expert provides. Overcoming fear and becoming curious will help you identify the aspects of your decision that can never be determined and allow you to make better choices.

As I learned from working with Annie Duke, whose expertise is poker not chess, the key is to make smart bets and then recognize that no bet on the future is a sure thing.

So, take it from Po. Even though you might be scared of the dark and can’t see what is down the road, that doesn’t mean you shouldn’t proceed forward, gathering the clues, getting help where you can and making the best financial decision you can with the information you have and the range of possible outcomes that the future presents.

Unfortunately, overcoming fear is not enough, and to truly be comfortable with “not knowing” you also need to overcome at least one other bit of psychological baggage that most of us carry, and for that I want to talk about what I learned from a different teacher.

Marilee Adams and the “Learner Mindset”

Marilee Adams is a writer friend who I got to know several years ago at a 3-day authors retreat sponsored by Berrett Kohler, the company that published my first book and several of Marilee’s. Marilee’s books have been hugely popular and despite our different statuses in the world of books and book sales, Marilee took an interest in my ideas and gave me a great deal of advice and support all throughout my process of writing Money Mountaineering.

In addition to having had the same publisher for our books, it seems that my suggested approach to the unknowability of the future is quite similar to aspects of Marilee’s advice on how to address uncertainty in general and how to gather enough information to make good decisions. As with many of my fellow authors, I had scanned Marilee’s book, but until this Spring I had never had the time to read it cover to cover.

That changed earlier this year when Marilee invited me to be a guest at one of her 4 week/8 session workshops on how to “Change Your Questions and Change your Life”. I didn’t have to think twice before accepting her generous offer because, in addition to the prospect of getting to watch how Marilee works her magic on large groups who flock to her usually sold-out workshops, I also sensed that her message to adopt a “Learner Mindset” when facing important life decisions might be very relevant to what is embodied in my 4th foundational principle of Holistic Financial Wellness. These two factors made it a very easy decision to devote the minimum 12-hour time investment to attending the workshop.

It turns out that adopting the Learner Mindset is not exactly the same as what I mean when I write about becoming comfortable with the uncertain future, but had I not gone to the workshop I would never have realized quite how important it is not to fall prey to anticipation, a state of mind that can lead you to make bad decisions – particularly financial ones.

Just like fear is the enemy of curiosity, I think anticipation is the enemy of open-mindedness. If you think you know what is going to happen (good or bad), then you can’t be open to the range of possible ways in which the future might unfold. And that is exactly what anticipation is — expecting something specific to happen while closing your mind to all the other possible paths the future might take.

This was not news to me, but during the workshop, Marilee went pretty deeply into what generates anticipation in us and what we should do to not let it bite us. And even though I have thought about uncertainty and how to deal with it for decades, I learned something important from Marilee and am grateful to her for reframing the problem of our tendency to think we know what will happen instead of what might happen in this way. She helped me understand in a deeper way one of the key things that cause us to sometimes lose our ability to think clearly and make good decisions in the face of an uncertain future.

That being said, my philosophy on the subject of uncertainty is, I believe, somewhat different than Marilee’s and in particular, I think we differ in our analysis of what allows us to overcome the fear and other obstacles that keep us from living comfortably in an uncertain world.

This is in no way a criticism of the value of what Marilee provides or the way she does it. For many people, Marilee’s approach to developing a “Learner Mind” is highly effective. The issue for me, however, is that in Marilee’s workshops (or at least the one I attended), there is a lot of homework, and I was asked to work harder than I was prepared to when I accepted her invitation.  For many, I realize that that, by itself, is a good thing, but in this case my personal idiosyncrasies prevented me from getting the full benefit of Marilee’s training.

My problem is that fundamentally I don’t like homework – I got away with not doing much in school and in many cases didn’t see the point of why it was assigned in the first place. My father and I had arguments about that, and like many things, he was more right than wrong in lecturing me for not doing my homework, but still, somehow, I came out ok.

Many believe that our minds can be trained to be curious, and maybe they can, but I think our ability to ask good questions can also come from a different source – specifically the wealth of natural curiosity that abounds within us, and just needs to be unlocked and allowed to emerge naturally.

For me, curiosity and disciplined practice/training just don’t mix, though just like Holistic Financial Wellness Principle #1 states, we are all unique individuals and different approaches to getting better at making good financial choices are appropriate for different people. Many of us welcome the discipline and skill development that Marilee imparts – and she is an extraordinarily good trainer in that regard, but I take a somewhat different approach to my own path to getting comfortable with “not knowing”.

Specifically, I believe that humans are at their best when they get in touch with that wild, playful, undisciplined adventurous side – a side that, if we were lucky, we enjoyed as a child and can still return to. For me at least, that’s where my curiosity lives.

So how do you get more curious and want to ask the questions you need to ask – about your job, your 401(k), your bank, or even cryptocurrency? I don’t believe there is a single answer to that question, but my approach is different than Marilee’s. Rather try to train myself to be curious, I simply listen to my own inner voice and pay attention to what I hear. Am I falling prey to anticipation when I think I know what is going to happen? Is it fear which keeps me from thinking about what might happen? Or is it a combination of both – throwing me off track as I hear myself say “I am afraid and don’t want to think about what I am sure will happen (in the market, the economy, my company, and even my family).”

It is also important to realize that being curious won’t necessarily help you to figure out what will happen next. Fundamentally, to make good financial decisions in an uncertain world, we need to remember that while the future is unpredictable it is not unimaginable. Being curious and open-minded is just the first necessary step towards financial wellness.

In the end, I believe that Marilee and I agree completely that to make better financial choices you need to be curious enough to ask the right questions and open-minded enough to listen to the answers.

That is what the Holistic Financial Wellness Principle #4 is all about.