The Psychology of Money Chapter 17: The Seduction of Pessimism

Airplanes “appear impossible”, wrote an article in 1889. Four years later in 1903, the Wright Brothers recorded their first flight. Many thought it was a trick, and nearly everyone was still skeptical about air travel for years. As long as six years later, another article said, “There will never be such a thing as commercial aerial freighters.” Just five months after that article, the first cargo plane took flight.

It goes without saying that air travel has changed the world. But it might surprise you that once the Wright Brothers first took flight, nobody seemed to care. Housel documents the history, that it took years after their first flight to get legitimate reporters to the Wright Brothers to document what was going on. And in fact, there was a publicity break for air travel when an Army Lieutenant was killed during a demonstration flight. Promise to change the world through flight and prove that it can be done, and most just shrug it off. Hear about one accidental death and reporters will line up with pen and pad in hand. Housel uses this story to prove a point: “tell someone that everything will be great and they're likely to either shrug you off or offer a skeptical eye. Tell someone they're in danger and you have their undivided attention.”

This is called asymmetric aversion, and it’s linked to our survival instinct. If something unexpected happens that’s a great improvement to our lives, we’re thrilled. If something unexpected happens that is going to ruin our lives, we would very much like to know so that we could avoid it.

It’s the same with global economics and financial markets. “Pessimism just sounds smarter and more plausible than optimism.” When was the last time you watched an economic news channel and heard that things will continue to get better? Usually that does not make headlines. But if you study history, it’s abundantly clear that “the world tends to get better for most people most of the time.” Pointing to present realities of injustice does not disprove this point. Another book I’m reading about the history of risk management (I know, riveting) explores when the first data was recorded on life expectancy. In the 1600s England, life expectancy at birth was around 17 years old. 94% of people did not reach age 56. Housel notes that age adjusted death due to heart disease in the U.S. dropped 70% since 1965, which is roughly half a million lives per year prolonged. Imagine a disaster that killed 1,000 people, let alone 500,000. Hurricane Katrina could occur 5 times per week every week. The weight we give to good news is very different from the weight we give to bad.

Success in our personal finances comes down to how we behave. So what does this have to do with our financial behavior?

1. Don’t be seduced by pessimism. My philosophy professor frequently said a mark of a well-trained mind is the ability to entertain an idea without being convinced by it. By all means, consider the stated dangers, but do so with the same skeptical eye that would give the door salesman who promises to take away all your problems.

2. Build a financial plan that assumes bad things will happen, which is something to be optimistic about. Markets will crash. You will crash (your car, and need a new one in the middle of the market crash). Your health will fail. None of this needs to ruin you financially. To give an example, if your plan is to spend all the investment growth from your investments each year (what some mean by “living on the interest”), what happens when we have a year with negative returns? If your $1,000,000 portfolio goes down 20% or $200,000, will you not only not spend any money that year from investments, but return the $200,000 so that you’re back to your starting point?

Let us know

• What recent news headline has caused you the most concern (financial or not)?

• What recent good news have you heard (whether personal or otherwise)?

Until next time, happy reading!