Would you call yourself “optimistic?” For some, “optimism” conjures up the R.E.M. song: “Shiny, happy people holding hands.” Yet how often have we felt – financially, physically, or relationally like “It won’t happen to me,” and been tragically wrong?
Behavioral economists have shown that we all have a bias toward optimism. This can be both a blessing and a risk. Let’s first look at what “optimism bias” is, and how common it is.
What Does Optimism Bias Look Like?
Optimism bias refers to our often-mistaken beliefs in: our forecasting abilities; our personal traits; and our chances of surviving a bad behavior or bad external event.
First, optimism bias can happen when we use the recent past to forecast the future. Examples:
If it was sunny yesterday, it will be sunny today. Things will stay the same.
If stocks went up yesterday, they will probably go up tomorrow. Things will stay the same.
If I am healthy today, I will be healthy tomorrow. In fact, I will be healthy for the foreseeable future. I am in good shape. Things will stay the same.
Second, optimism bias happens when we believe our unique traits will prevent misfortune. For example, before pandemic days, 60% of new restaurants were out of business in 3 years.* How many new restaurateurs knew this and went forward anyway?
Finally, there is the general “It won’t happen to me” optimism. Spring breakers on Clearwater Beach in 2020 come to mind. Or, surfers during a hurricane. Yet all of us have some version of “it won’t happen to me.” We think the stats don’t apply to us.
Things Will Stay the Same. Until…
In my mid-40s I went for an annual checkup. Everything was sailing along as the doctor checked my blood work: Normal, normal, normal. (“Yeah, yeah, yeah, why do I even get physicals? I am normal and have been all my life. Things will stay the same.”)
Then she paused. “Ok, Holly, so what we have here is an elevated….” (“What? Great, I have to take a pill.”) Things will stay the same. Until they don’t.
As so many have painfully learned this year, it is not possible to hedge against every unforeseen event. However, to be real, we look at statistics on what events are more likely than others. We do this to hedge against optimism bias.
If you live on the water, you are more likely to have wind and flood damage. So you buy storm and flood insurance.
If both of your parents had cancer, you are more likely to have cancer. So you don’t smoke, eat well, get your colonoscopy, and exercise.
If you own stocks for a long time, you will experience a downturn. So you also have bonds and cash.
If you have longevity in your family, dementia is more likely. So you make a plan for that.
Hedging Against Dementia
Dementia is one area where financial planners see a lot of optimism bias. Even in the face of statistics, it can be hard to appreciate the potential costs involved. I do not sell long term care insurance, but I do encourage people over 50 to consider it if a $500,000 – $900,000 dent in their future net worth might impoverish them.
It is difficult, though, to plunk down large premiums now for some unknown so far in the future, especially when you feel just fine. It’s easy to assume things will stay the same. But insurers have become very picky. Once you begin to show small symptoms, it is too late. You cannot get coverage. (Got a parent or spouse with optimism bias? Insurance coverage may not be the prettiest gift, but it may bring the most gratitude from family later.)
A few statistics: In-home caregivers will be in high demand by 2030. At $20 per hour (in today’s dollars), even twenty hours a week in dementia’s early stages adds up to $1600/month. The average life expectancy from an Alzheimer’s diagnosis is eight to ten years. (See the website of the Alzheimer’s association:https://www.alz.org/alzheimers-dementia/stages).
If you can’t imagine yourself or your family member needing a caregiver, a wheelchair, or even a daily pill, that’s human and that’s ok. But before deciding based on a gut feeling, consult some statistics and plug them into a plan. Optimism is great, but it’s best to also be real.
As we have seen in 2020, things stay the same, for a while, until they don’t.
*Daniel Kahneman, Thinking: Fast and Slow, Farrar, Strauss and Giroux, New York, 2011, p. 257.