Leveraging Optimism Bias as Planning Tool

Knowing the reasons for and roots of the optimism bias can help clients appreciate risk.

Advisors are well aware that clients underestimate the chances of bad things happening to them as well as the importance of planning to maintain one’s quality of life, yet few advisors have insight into why. Understanding the reasons behind the optimism bias can help advisors guide clients to a realistic approach in assessing and planning for risk.

Making advisors aware of the scientific research that explores those reasons is an important initiative at Prudential. “When it comes to planning for one's financial future, being overly optimistic may have harsh consequences for individuals and their families,” said Niharika Shah, Vice President, Head of Brand Marketing and Advertising for Prudential.

Shah said that Prudential believes that advisors and the individuals they serve should plan for the future realistically so that clients and their families can continue to pursue their life's ambitions, even in unfortunate circumstances such as death, critical illness or disability.

We’re hardwired to be optimistic

Tali Sharot, author of “The Optimism Bias: A Tour of the Irrationally Positive Brain” and associate professor (reader) at the department of experimental psychology at University College London, has conducted several research studies that show the bias toward optimism is related to the interaction between the frontal lobes and the deep structures of the brain that process emotion and motivation.

Some evidence also suggests that specific genes are related to optimism. When it comes to the reasons people have the bias, Sharot said there’s a relationship with human survival and that human health and motivation benefit from being optimistic.

“Optimism keeps our minds at ease, lowers stress, and improves physical health,” she said. “For example, a study of cancer patients revealed that pessimistic patients under the age of 60 were more likely to die within eight months than non-pessimistic patients of the same initial health, status, and age.”

James A. Shepperd, professor of social psychology at the University of Florida, said that motivation and persistence are two benefits for optimists. “Optimism can energize people to forge on, for example, with an awful medical treatment because they believe that things will improve. In some ways, it may become a self-fulfilling prophecy.”

Despite the prevalence of the bias, most people are unaware they have it. “Many people believe they are realists, or even pessimists,” Sharot said. “But when you test them in the lab they turn out to be as optimistic as the next guy. This is because our own optimism bias is not something we are aware of. It is a trick our brain plays on us without being conscious of it.”

“It is human nature to be optimistic,” Shah said. “We tend to think bad things happen to other people, but not to us, which is an amazing human behavior and one that keeps us motivated and focused on positive momentum.”

The downside of optimism

“Too-positive assumptions can lead to disastrous miscalculations—make us less likely to get health checkups, apply sunscreen or open a saving account,” Sharot said.

Prudential financial advisor Amanda Panico, CLU, CFP, has had firsthand experience with miscalculations and clients’ not taking precautions. “There are the people who are terrible savers, who have no follow-up or plan, and they expect you turn a little money into a lot of money because they think that the laws of compounding will make up for their lack of savings. It creates a false sense of security that makes people save too little for retirement.”

Putting the bias to work

With information about the benefits of the bias and its relationship to the brain, it seems unlikely that people will abandon their optimism. “In general, people are loathed to shelve their optimism,” Shepperd said.

While people persist in applying the bias to their personal futures, Sharot said that people are not looking for magical solutions. They recognize that they have the power to make things turn out okay.

Shepperd takes a similar position. “Optimism grounded in behavior can be a good thing. That is, predicting a positive future is not unrealistic if you are taking the steps to ensure that the desired event transpires. Having enough savings to retire doesn’t come from wishing it so. It requires taking actions today to achieve the desired goal.”

Positive information has influence

In research conducted by Sharot in her lab, they found that presenting information to study participants about their risks had very different outcomes depending on positive or negative communication.

Sharot said, “So for example, if someone said, ‘My likelihood of suffering from cancer is about 50 percent,’ and we said, ‘Hey, good news. The average likelihood is only 30 percent,’ the next time around they would say, ‘Well maybe my likelihood is about 35 percent.’ So they learned quickly and efficiently.”

But being positive is not just related to offering statistics. Panico said that it’s products themselves that can help balance a client’s unwillingness to plan for risk.

“Hybrid products really help with the optimism bias: for instance, annuities with market capabilities plus living benefit protection riders—just in case the market crashes. You’re preparing clients for the worst but they can hope for the best,” she said.

When consumers are especially optimistically biased when discussing the risk of future chronic illness, Panico frames the risk by discussing upsides. “Life insurance with chronic illness riders, for instance. We can say to the client, ‘You may not experience these events, and if you don’t, then you’ll still have a life insurance benefit that leaves a legacy.’”

Finding the balance

“The key here really is knowledge. We're not born with an innate understanding of our biases. These have to be identified by scientific investigation. But the good news is that becoming aware of the optimism bias does not shatter the illusion,” Sharot said.

When clients are aware that they may be motivated by optimism bias and advisors understand the complexity and source of that thinking, it creates opportunities to help clients fully appreciate their risks and plan effectively.

“Once we are made aware of our optimistic illusions, we can act to protect ourselves,” said Sharot. “It is possible to strike a balance, to believe we will stay healthy, but get medical insurance anyway.”

Today, Americans are misjudging their futures and are woefully unprepared, in part because of the optimism bias. With in-depth knowledge of the bias and its source, advisors can create a new trajectory for clients—one with proper planning that identifies real risks and addresses their potentially devastating impacts.