The Optimism Trap: How We Misjudge Risk and Rewards

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There is a quirk in human nature that is as old as time itself. Yet, it is as relevant today as it was when our ancestors first started trading seashells.

I am talking about the tendency to see the world through rose-coloured glasses when it comes to potential gains, while simultaneously downplaying the very real risks that lurk in the shadows.

Now, this not just a passing academic observation, but a force that affects not only our everyday lives but also our economies and even the path of history. And it is worth pausing to think about how it might be affecting your own choices, big and small…in life, investing, everywhere.

The Siren Song of Success

Consider the most recent lottery ticket purchase you made or a gamble you played. Did you spend even a fraction of the time imagining losing that money you paid for the ticket as you did daydreaming about what you would do with crores or millions?

Or think about that risky stock pick your friend or brother-in-law told you about recently, where he asked you to bet a large part of your savings. Did you imagine spending your winnings on a foreign trip or perhaps even having to justify to your spouse why the money you had set aside for your children’s education had suddenly vanished?

Well, life looks beautiful when we see the bright side. It is the engine of progress, entrepreneurship, and invention. Without this tendency toward optimism, we might never take the chances required to do great things.

Imagine if every potential entrepreneur fixated solely on the high failure rate of new businesses. There would be no innovation. The Wright brothers might have never left the ground if they had dwelled exclusively on the dangers of flight.

So, while our inclination towards optimism pushes us to explore, create, and strive for better, it also needs to be understood and appreciated, just like any other strong force.

If you let it run uncontrolled, it may cause you to make poor decisions that have painful outcomes. The secret is to take advantage of this strong desire but to control it with reason and risk assessment.

The Slow Compounding of Caution

Anyways, the other side of our human nature is that we have a tendency to ignore possible downsides. “It won’t happen to me,” we assure ourselves.

We ignore ‘boring stuff’ like insurance, emergency funds, and diversification because we do not see them as contributing to our aspirations of quick riches. It is, after all, far more thrilling to imagine doubling your money on a hot stock tip than to think about the steady, unremarkable growth of a portfolio of diversified mutual funds.

But the problem is that true financial security often results from the slow compounding of prudent decisions, much like in nature, where the most remarkable growth occurs silently over extended periods of time. It may not be glitzy or spark lively discussions at social gatherings, but it is the foundation of long-term prosperity.

What makes adopting the ‘boring’ and ‘slow’ in investing, as in life, is that accepting them requires mental adjustment.

It involves putting stability and long-term development ahead of the excitement of possible rapid benefits.

It involves developing self-control and patience in light of the fact that most significant accomplishments typically result from consistent effort over long periods of time.

But this is how we create a strong foundation for our financial security and general well-being – by realising the value of steady, incremental advancement.

Also, this gives us something far more precious than the quick satisfaction of more speculative efforts – the stability and peace of mind that come from knowing you are constantly moving towards a secure future.

Finding Balance in an Unbalanced World

So, how do we deal with this psychological quirk? How can we utilise optimism’s potential without succumbing to its excesses? I can think of a few ways –

• Develop self-awareness: Identify when you are losing yourself in the thrill of possible profits. Even if it seems strange, take a step back and make yourself think about the negative aspects.
• Seek out different viewpoints: We frequently are blind to our own prejudices. Talk to people who have different perspectives; they may be able to point out opportunities or risks that you are blind to.
• Accept the power of ‘enough’: Identify your own definition of success, free from social comparisons. You can make reasonable risk and reward assessments when your personal objectives are well-defined.
• Practice patience: Remind yourself that nothing happens quickly in nature. Give your choices time to come to pass and resist the temptation to follow the quick fixes and instant success stories.
• Take a lesson from history: Study previous manias, collapses, and bubbles. You will become aware of trends and develop a healthy dose of scepticism regarding claims that “this time is different.”

Ultimately, your goal in investing or outside of it is not to eradicate your optimism or let caution paralyse your decision-making. It is to strike a balance between having high dreams and keeping your feet firmly planted in reality.

You may make better judgements, create a more stable financial life, and possibly even discover a greater feeling of contentment along the way if you are aware of this basic human inclination.

After all, real wisdom is not about being correct all the time but about understanding the long-term effects of your choices, both good and bad.

With that awareness, you can slowly design your future, one thoughtful decision at a time.

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That’s all from me for today.

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~ Vishal