Optimism bias and overconfidence effects in financial decision making

When considering our future, we tend to overplay the good stuff and downplay the bad.

Our inclination to be too hopeful leads us to overstate the expected success of our investments consistently, the chances of achieving our future dreams, or even our perceived ability to avoid a car accident while driving drunk when compared to our friends.

Our brain has a built-in optimism bias. People tend to overestimate the expectation of positive events and underestimate the anticipation of adverse events happening to them in the future; Experts believe that our brains may be wired by evolution to see the glass half-full. This phenomenon is also often referred to as “the illusion of invulnerability,” “unrealistic optimism,” and a “personal fable.”

This Bias leads us to believe that we can live longer than the average, or our children will be more intelligent than the average, or they will be more successful than the average population. However, we can’t all be above average. The ​optimism bias is essentially a mistaken belief that our chances of experiencing adverse events are lower.

We can see how optimism bias impacts economists and financial markets. Our chances of encountering positive events are higher than those of our peers.

Optimism bias leads investors to overestimate economic forecasts along with had inflated expectations of financial growth and success. As a result, banks and financial institutes continue to engage in high-risk decision-making and contribute to economic bubbles.

For a Product Manager, It’s essential to invalidate the potentially huge costs of the positivity bias when estimating the expected time or cost to finish a task or project. Governments have this problem consistently to factor the Bias into planning large projects. Unfortunately, we humans are notoriously bad at adhering to these estimates, as we always tend to think it’ll take a lot less time or cost than it does. So, as a project manager, identify to factor in an Optimism Bias multiplier into estimations given.

Interestingly, because of the absence of unrealistic levels of Optimism, those with mild depression are much more accurate at predicting future events, seeing the world ‘as it is, rather than perhaps how we’d like it to be. The effect isn’t uniform across everyone. Though it’s shared across gender, age and culture, rather aptly, the Optimism Bias doesn’t seem to kick in for people suffering from depression.

Anirudh is not a best seller author and has not sold any books but likes to write about Phycology, Economics, behavioral finance, and product management.