A few weeks ago, Marin kayaker Cyril Derreumaux pushed off from Sausalito before dawn to paddle alone across 2,400 nautical miles of open ocean to Hawaii. He had prepared three years for the journey and expected it would take him seventy days.
More experienced kayaker friends noted that his boat hadn’t been tested against the ocean, and the longest solo trip he’d done had been a nine-day trip down the Sacramento River. One friend, Carter Johnson, who holds Guinness World Records for long-distance paddling, warned that he was “stepping off into the abyss.”
Derreumaux shrugged off the concerns: “People think you have to have done something like this before to do it for the first time,” he said. “It will be a very big challenge for me, but I’ll manage.”
He managed to get only 54 nautical miles west of Santa Cruz before calling it quits six days later. He was seasick, had GPS problems, and had lost his anchor after the lines got tangled in his rudder. At least there wasn’t a crowd to see him hoisted in a rescue harness into a Coast Guard helicopter shortly after midnight, his kayak left to drift in the ocean.
Derreumaux acknowledged that “he hadn’t been ready for the conditions,” but said. “I don’t think it’s a lack of preparation. It’s a lack of experience. In general, nobody knows about crossing the ocean in a kayak.”
It seemed like an odd assessment. He’d barely begun his journey -- hadn’t he thought about large waves, strong currents, and potential equipment failure?
Yet similar self-assessments are drawn every day by the initiators of failed plans. An investment manager making risky bets complains that the market turned against them. A business executive says it was impossible to foresee changed circumstances that sank a project.
It’s always tempting to blame fate and bad luck alone. But when ventures fail, it’s more often a collaboration with poor preparation based on an overly optimistic assessment of the odds at hand.
How Optimism Undermines Preparation
Optimism is the fuel of adventure and the great undertakings in our lives. It’s embedded in the flash of inspiration and the beautiful vision of what might be achieved by the journey’s end. But as Nobel Laureate Daniel Kahneman has noted:
Most of us view the world as more benign than it really is, or our own attributes as more favorable than they truly are, and the goals we adopt as more achievable than they are likely to be. We also tend to exaggerate our ability to forecast the future, which fosters optimistic overconfidence.1
Such optimism, he explains, is more than wishful thinking; it derives from cognitive biases that are biologically hardwired into us. These biases encourage us to focus only on our goals and circumstances rather than drawing on the broader experience that others have had with our situation. They egg us on to believe that our skill and personal efforts will determine an outcome more than luck, and they persuade us to “focus on what we know and neglect what we do not know.”2
Derreumaux may well have believed that the obstacles he encountered were peculiar to his situation. However, it was common knowledge that breaking away from the strong currents near the California coast was “excruciatingly difficult.” The year before, a rower had spent six weeks being sucked south by those currents toward Baja. Just before Derrremaux’s launch, an Australian rower leaving from Monterey had gotten “trapped in a tunnel of unrelenting northerly winds'' and had written a blog post “praying for a change in winds, calmer and more westerly, and less sea sickness.”
Even if Derreumaux had read the blog post, though, it probably wouldn’t have changed his plans. As Kahneman explains, the nature of cognitive biases is such that they can create blind spots which prevent us seeing even the evidence of our own experience, much less that of others.
He recounts a story about leading a project to develop a textbook and asking team members to estimate how long it would take them. One member with previous experience knew that many similar projects had failed and those that didn’t had taken seven years on average to complete. Yet he still predicted, along with everyone else, that it would take only a couple of years to produce the textbook. It took eight years and by then the publisher was no longer interested.
Personal Finance is Fertile Ground For Optimism
Businesses and institutions routinely fall prey to the optimistic view. Executives low-ball cost estimates for their projects to get them approved; pension plans project rosy investment returns to avoid contributing as much for employees; commercial landlords and lenders tell themselves building occupancy rates will spring back to previous levels once the pandemic subsides.
It should be no surprise that individuals fall prey to similar delusions with their personal finances. A recent study by the University of Southern California’s Center for Economic and Social Research found that workers are overly optimistic about their future Social Security benefits, which is one reason so many people don’t save enough for retirement.
They expect home renovations to be completed on time and on budget. They overestimate their ability to save and their ability to withstand market fluctuations. They underestimate the odds of losses and setbacks with their homes, jobs, and health.
Information and education would seem like a cure for these ills. However, our cognitive biases run too deep to be swayed by data and logic. We want what we want, and our desires leave us vulnerable to making financial plans out of straw and sticks rather than brick.
We’re suckers for a good story, which can override anything the data tells us, and in the continual battle for financial resources between our current and future selves, our future selves are always prone to lose.
Overcoming the Fog of Optimism
Are we doomed to disappointment with our long-term plans unless luck bails us out? Not necessarily. Kahneman offers a number of helpful correctives.
Every battle is won before it’s ever fought. ― Sun Tzu
Get the Outside View
Rather than base expectations solely on our own experience and opinions - what Kahneman calls the “inside view” - we can look for the “outside view” in the broader experience of other people.
As an example, we could look at data such as the 2002 study Kahneman cites showing that home renovations typically cost twice as much as the initial estimates to create a “base case.” We could then talk to friends and neighbors in our area about their own renovation experiences to help adjust the base case to our situation - for example, by factoring in the possibility that our hundred-year-old home in San Francisco could require a new foundation, since concrete tends to crumble after a century or so.
Hofstadter's Law: It always takes longer than you expect, even when you take into account Hofstadter's Law. ― Cognitive scientist Douglas Hofstadter
With financial plans, there’s plenty of data to build a base case with key variables such as life expectancy, inflation rates and investment returns. We can use this data as a starting point and then adjust it to fit our particular circumstances in order to develop a set of reasonable expectations.
Do a Premortem
Getting the outside view can do a lot to improve our plans, but as Kahneman notes, it’s also easy to disregard information that contradicts what we want to hear:
'Pallid’ statistical information is routinely discarded when it is incompatible with one’s personal impressions of a case. In the competition with the inside view, the outside view doesn’t stand a chance.3
In fact, given our propensity to focus solely on what we want and avoid looking at things that could get in our way, it can be difficult even to imagine the potential obstacles. For this, we need stronger medicine, and Kahneman recommends using an exercise known as a “premortem”:
Imagine that we are a year into the future. We implemented the plan as it now exists. The outcome was a disaster. Please take 5 to 10 minutes to write a brief history of that disaster.
While the exercise can be challenging, it engages our imaginations and legitimizes doubts, helping us imagine alternative paths and how we would respond to them. All of this can help free us from our tendency to take a more binary, black-and-white approach to planning decisions.
With planning software, we can model a lot of the questions with what-if scenarios: what if inflation or investment returns are different than expected? What if my income declines, spending rises, or a large financial setback occurs?
While rosy projections may feel better, they inject risk into our plans and don’t do us any favors. Better to plan strategically now than be forced to react under duress later.
Account for the Unknown Unknowns
No matter how hard we try, we can’t imagine into every setback we might encounter:
There are many ways for any plan to fail, and although most of them are too improbable to be anticipated, the likelihood that something will go wrong in a big project is high.4
Or, as a client summed it up recently, “It’s not the truck you’re watching that will hit you.”
With financial plans, the best we can do is build in cushion or “margin of safety” for the inevitable, but completely unpredictable surprises we’ll encounter along the way. Even though we couldn’t foresee the global pandemic that hit last year, we could have anticipated some kind of personal setback, which could have been even worse, and then planned accordingly.
Murphy’s Law— if anything can go wrong, it will.
There are numerous ways to build financial cushion into a long-term plan. For instance, when clients are planning a home renovation, we advise them to seek three quotes and add them together. The clients usually expect us to advise taking the average of the three quotes and using that as their estimate, but we don’t. We say “get three quotes, add them together . . . and that’s your estimate.” (It may be a joke to lighten the mood, but anecdotally, it’s also turned out to be a pretty accurate forecasting method.)
Other ways to build financial cushion include guessing high on expenses and low on income when evaluating cash flow; avoiding home equity and inheritances as a source of funding for goals; ignoring the possibility of year-end bonuses when setting savings goals; purchasing insurance to protect property, health, and income.
Using these tools - the outside view, the premortem, and factoring in surprises - won’t produce a crystal ball, but it should increase your odds of success. You’ll likely sleep better at night, have more confidence in your plans, and be justified in thinking that you’re prepared for most of the surprises that might arrive. In other words, you’ll have grounds for optimism as you set out on your journey and be more likely to persevere along the way.