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The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it
being true.
What was the happiest day of your life?
The documentary How to Live Forever asks that innocent question to a centenarian who offered an amazing response.
“Armistice Day,” she said, referring to the 1918 agreement that ended World War I.
“Why?” the producer asks.
“Because we knew there would be no more wars ever again,” she says.
World War II began 21 years later, killing 75 million people.
There are many things in life that we think are true because we desperately want them to be true.
I call these things “appealing fictions.” They have a big impact on how we think about money—particularly investments and the economy.
An appealing fiction happens when you are smart, you want to find solutions, but face a combination of limited control and high stakes.
They are extremely powerful. They can make you believe just about anything.
Take a short example.
Ali Hajaji’s son was sick. Elders in his Yemeni village proposed a folk remedy: shove the tip of a burning stick through his son’s chest to drain the sickness from his body.
After the procedure, Hajaji told The New York Times: “When you have no money, and your son is sick, you’ll believe anything.”⁶⁴
Medicine predates useful medicine by thousands of years. Before the scientific method and the discovery of germs there was blood-letting, starvation therapy, cutting holes in your body to let the evils out, and other treatments that did nothing but hasten your demise.
It seems crazy. But if you desperately need a solution and a good one isn’t known or readily available to you, the path of least resistance is toward Hajaji’s reasoning: willing to believe anything. Not just try anything, but believe it.
Chronicling the Great Plague of London, Daniel Defoe wrote in 1722:
The people were more addicted to prophecies and astrological conjurations, dreams, and old wives’ tales than ever they were before or since … almanacs frighted them terribly … the posts of houses and corners of streets were plastered over with doctors’ bills and papers of ignorant fellows, quacking and inviting the people to come to them for remedies, which was generally set off with such flourishes as these: ‘Infallible preventive pills against the plague.’ ‘Neverfailing preservatives against the infection.’ ‘Sovereign cordials against the corruption of the air.’
The plague killed a quarter of Londoners in 18 months. You’ll believe just about anything when the stakes are that high.
Now think about how the same set of limited information and high stakes impact our financial decisions.
Why do people listen to TV investment commentary that has little track record of success? Partly because the stakes are so high in investing. Get a few stock picks right and you can become rich without much effort. If there’s a 1% chance that someone’s prediction will come true, and it coming true will change your life, it’s not crazy to pay attention—just in case.
And there are so many financial opinions that once you pick a strategy or side, you become invested in them both financially and mentally. If you want a certain stock to rise 10-fold, that’s your tribe. If you think a certain economic policy will spark hyperinflation, that’s your side.
These may be low-probability bets. The problem is that viewers can’t, or don’t, calibrate low odds, like a 1% chance. Many default to a firm belief that what they want to be true is unequivocally true. But they’re only doing that because the possibility of a huge outcome exists.
Investing is one of the only fields that offers daily opportunities for extreme rewards. People believe in financial quackery in a way they never would for, say, weather quackery because the rewards for correctly predicting what the stock market will do next week are in a different universe than the rewards for predicting whether it will be sunny or rainy next week.
Consider that 85% of active mutual funds underperformed their benchmark over the 10 years ending 2018.⁶⁵ That figure has been fairly stable for generations. You would think an industry with such poor performance would be a niche service and have a hard time staying in business. But there’s almost five trillion dollars invested in these funds.⁶⁶ Give someone the chance of investing alongside “the next Warren Buffett” and they’ll believe with such faith that millions of people will put their life savings behind it.
Or take Bernie Madoff. In hindsight his Ponzi scheme should have been obvious. He reported returns that never varied, they were audited by a relatively unknown accounting firm, and he refused to release much information on how the returns were achieved. Yet Madoff raised billions of dollars from some of
the most sophisticated investors in the world. He told a good story, and people wanted to believe it.
This is a big part of why room for error, flexibility, and financial independence—important themes discussed in previous chapters—are indispensable.
The bigger the gap between what you want to be true and what you need to be true to have an acceptable outcome, the more you are protecting yourself from falling victim to an appealing financial fiction.
When thinking about room for error in a forecast it is tempting to think that potential outcomes range from you being just right enough to you being very, very right. But the biggest risk is that you want something to be true so badly that the range of your forecast isn’t even in the same ballpark as reality.
In its last 2007 meeting the Federal Reserve predicted what economic growth would be in 2008 and 2009.⁶⁷ Already weary of a weakening economy, it was not optimistic. It predicted a range of potential growth—1.6% growth on the low end, 2.8% on the high end. That was its margin of safety, its room for error. In reality the economy contracted by more than 2%, meaning the Fed’s low-end estimate was off by almost threefold.
It’s hard for a policymaker to predict an outright recession, because a recession will make their careers complicated. So even worst-case projections rarely expect anything worse than just “slow-ish” growth. It’s an appealing fiction, and it’s easy to believe because expecting anything worse is too painful to consider.
Policymakers are easy targets for criticism, but all of us do this to some extent. And we do it in both directions. If you think a recession is coming and you cash out your stocks in anticipation, your view of the economy is suddenly going to be warped by what you want to happen. Every blip, every anecdote, will look like a sign that doom has arrived—maybe not because it has, but because you want it to.
Incentives are a powerful motivator, and we should always remember how they influence our own financial goals and
outlooks. It can’t be overstated: there is no greater force in finance than room for error, and the higher the stakes, the wider it should be.
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