For this, my final essay on the principles of Holistic Financial Wellness, I need to disclose some aspects of my life that in normal circumstances I would never consider writing about and posting where strangers can read. I do so, however, because throughout Money Mountaineering and in the previous 5 essays, I have not shied away from sharing aspects of my life that bear directly on the issues I am discussing. To not do this now, would be the height of hypocrisy.
HFW #6 is all about our irrationality and the blind spots we all have when it comes to making important financial decisions. It advises you to strive for “fearless self-awareness” and to take note of our limitations when we consider our own situations and the areas where we may need help. So today I want to walk my talk and share one of my blind spots that have disrupted my financial life, and unfortunately weren’t explicitly addressed in Money Mountaineering.
In What’s Your Future Worth? and in Money Mountaineering, I have expressed my view that predicting the future is impossible, but imagining it is not. In fact, my recent essay about HFW#4 addresses this directly by noting how important it is not to anticipate what the future will hold, but instead, we try to imagine what might happen and then prepare for it. In my most recent essay on HFW #5, I counseled that you follow my father’s advice and “hope for the best but prepare for the worst.”
And while I have generally been able to adhere to the 6 principles I espouse, my financial life was recently upended by one of the most important financial contingencies out there that affects several hundred thousand of us every year and millions overall. In retrospect, I wish I would have included at least a brief discussion of it in Money Mountaineering, but for reasons that will soon be apparent, I didn’t. This essay is my attempt to rectify that omission, while at the same time expanding on the notion of what I mean when I say that financial wellness requires that we “acknowledge our cognitive and emotional limitations as human beings.”
Optimism Bias and a Failure of Imagination
In Chapter 11 of Money Mountaineering, I describe what I consider to be the most important emotional biases and cognitive errors that we can fall prey to when we make financial decisions. In preparation for writing Money Mountaineering, I reviewed much of the Behavioral Economics literature and discovered that in the years since I had been immersed in the subject, many more “system bugs” in our makeup had been discovered and explored. To make the book as useful as possible, I decided to focus on what I considered to be the most important and “dangerous” aspects of our “programming errors” that can prevent you from making good financial decisions.
In the book, I describe 8 emotional biases and 7 systematic cognitive errors that we are all prone to, but I left out one emotional bias that not only is important but is also one that I recently fell prey to in my own life. Ironically enough it was probably this bias itself that caused me not to explicitly address it anywhere in the book, and it is one that I want to talk about now. Specifically, I am referring to what is called “Optimism Bias”.
Optimism bias is a bias that “causes someone to believe that they themselves are less likely (vs what the actual probabilities are) to experience a negative event” (see for example https://en.wikipedia.org/wiki/Optimism_bias). While this bias has been observed by psychologists since the 1980s, systematic analysis of this bias only began in the last 20 years (see for example http://www.crossingdialogues.com/Ms-A14-09.pdf).
I doubt that adding one more bias to my Chapter 11 catalog of our emotional biases and cognitive errors would have made for better reading, but still, I regret not discussing it – especially because the financial consequences of optimism bias can be significant.
Right now, I am suffering the consequences of what can happen if you ignore the full range of unpleasant ways a decision might turn out. Fundamentally, I experienced a failure of imagination and I want to talk now about how it happened.
Time Traveling and Imagining a Painful Future
In the last chapter of my first book What’s Your Future Worth? I describe the first conversation I had with my wife about our respective personal balance sheets. It happened on our very first date as we were getting to know each other, both of us very much realizing that we liked each other very much. We disclosed our financial situations to each other — my significant accumulated assets and her bright red ledger full of student debt accumulated in pursuit of her Ph.D. I had no doubt in my mind that pursuing her was the right thing to do, and in the book, I describe my thought process (clouded by emotional biases of all sorts as it undoubtedly was).
That initial conversation took place in 1995, and the next time we addressed the subject was shortly before we got married at the end of 1998.
In that second conversation a few months before our wedding date, my bride-to-be asked me whether I was going to ask her to sign a pre-nuptial agreement to deal with the wildly different financial situations we were bringing to the marriage.
This question was, in one sense, not about money, but in another sense, it was only about money. In fact, it was a very specific question about what would happen to our money during the marriage, and more importantly – what would happen to our money if our marriage did not survive.
It was not as if I hadn’t thought about the question. I had. In fact, I had thought very deeply about it and when my fiancé asked the question, I was not the least bit surprised.
Before I tell you how I answered her, I need to first acknowledge what many of you already know, but perhaps some of you don’t. My wife and I separated at the end of March 2020 shortly after COVID locked us down together in our house in Berkeley. I moved out to live full-time at our farm in Santa Rosa, and that is where I live now.
We are currently in the process of working through the excruciating details of a legal divorce that I hope will end soon. As I say, Divorce is a financially significant life contingency that affects many hundreds of thousands of married couples every year. And that is in normal years when there are no wars or pandemics – events that seem to bring some families closer and blow others apart. For example, right after World War II the divorce rate in the US was dramatically higher than it was in 1955, just a few years later when my parents got married (3.7 per 1000 people in 1947 vs 2.3 per 1000 in 1955) My parents recently celebrated their 66th wedding anniversary, but I won’t — even though the annual divorce rate throughout most of my marriage has “only” been between 3.5 and 4 per 1000 each year (https://divorcescience.org/2013/03/12/us-divorce-rate-2001-2011/).
Part of the issue is just pure math. Note that over a 20-year marriage even a 3.5% annual divorce rate means that you will have less than a 50-50 chance of emerging from two decades still together. This was a fact that I was well aware of when I got married, but I did not let that dissuade me. For me, the risk was far, far outweighed by other non-financial considerations, and if you read What’s Your Future Worth? you will understand why.
I think there are two main reasons that I am in my current situation. The first and obvious reason is that I simply fell prey to optimism bias. The fact is, I just didn’t believe it would happen to us. It’s not like I shouldn’t have known better. As I said, the data told a pretty clear story. But the problem with average data is that we all like to believe we are not average. In fact, we aren’t, but averages do matter, and our emotional biases very often steer us to ignore the odds that we can use to make better decisions.
Actuaries are people too, and I was not immune to the perils I outline in Chapter 11. I was convinced I knew better, and even though I periodically visited actuarial websites where an algorithm would calculate my actual individualized odds (always telling me I was a heavy favorite to get divorced), I simply would find reasons for their being wrong. Finally admitting defeat was not easy. Especially when my optimism bias made it so much harder to realize that my marriage was finally over.
Had I realized what was happening at the time I might have written about it, but had I done so, I wouldn’t have written it in the way I would now. I understand the nature of the financial risk divorce poses much better now and it is a very complicated one, particularly with respect to the timelines and unexpected financial surprises (mostly bad) that inevitably arise when two human beings decide to end their marriage. We are not rational creatures, and I guess that is why we have lawyers to help us sort things out.
That being said, there was a time when I was thinking pretty rationally, and that was before the marriage. When my fiancé and I sat down to discuss the prenup, I had done my work on considering as many scenarios as I could imagine, but almost all of them involved enduring some very painful Time Traveling, and while I did do my due diligence and took steps to prepare for the contingency, it was not an exercise I enjoyed or did particularly well.
The fact of the matter is that not only is every individual’s probability of getting divorced a function of many variables – some known, like age and duration of marriage but there are many others that are unknown and often random. And not just random, many are random events that come from an unknown distribution that we can never discern.
One thing I did do, and you can do as well – in addressing this as well as all the other life contingencies that you don’t want to think about — is to ask yourself a lot of “what if” questions and then try to inhabit your future self. When you get there, look at the possible financial situation you will find yourself in, and try to imagine how you will feel under each one. It’s painful work, but it can help you make better financial decisions.
These days, when I am often tempted to kick myself for making a bonehead decision, I remember Annie Duke’s counsel against “resulting” – i.e., thinking you made a mistake just because your decision turned out badly. I still feel like I did the right thing, it just didn’t turn out as I had hoped.
For obvious reasons—both legal and ethical, I won’t disclose any more of the details of my divorce. I will, however, tell you the rest of the conversation my wife and I had before we got married – at least I will tell you my memory of my side of the conversation. I do so because one of the first decisions you might have to make before you get married and before you must decide whether to say “I do” to whoever is empowered to witness your contract, is to decide whether or not to have a prenup.
As you may have come to realize – I don’t like to give advice. Instead, I’d rather simply tell you what I did and why I did it.
My fiancé asked me whether I was going to ask her to sign a prenup before we got married and I said no. I said I thought that California Divorce law was perfectly reasonable – whatever assets each party brings to the marriage is separate property and only the assets that we would acquire as a couple would be split 50-50. For me that was fair, and I didn’t see any need to make it any more complicated than that.
I still believe it was a reasonable decision and I would make the same decision today if I was faced with that choice. However, I now know, and I want you to know that I materially underestimated how complicated (and painful) ending a long-term marriage like ours could be – but that is another story that is yet to be written.
This is the last essay that will be posted before Money Mountaineering is published in a few days, and I want to sign off on a more optimistic note because even though I have not been immunized against optimism bias, I am fundamentally an optimistic person even though I act with more than a little caution about the extreme risks, both financial and otherwise, that lurk in the wilderness in which we live. It is reflected in how I manage my financial life, and I am sure it affects the lens through which I consider financial decisions.
And so, the last message I want to give you about Money Mountaineering is this. I hope that my book will help you see some things about your money that you hadn’t, but I also want you to do your due diligence on me. As I say, I try not to advise anyone on what I think they should do but instead will tell you what I do and why. In the end, you are the expert on your own financial decisions and the only one who can ultimately make them.
I hope you choose to read about my ideas, and you find them helpful.
Happy trails, Pete
About Peter Neuwirth: Since graduating from Harvard with a degree in mathematics and linguistics in 1979, Peter Neuwirth has held actuary leadership positions at consulting firms including Aon, Hewitt Associates, Watson Wyatt Towers, Perrin, and Towers Watson. He also ran the actuarial firm Coates Kenney and spent a year at Price Waterhouse.
Currently a Fellow of the Society of Actuaries and the Conference of Consulting Actuaries, Pete regularly consults with the largest corporations in the world about their retirement plans with a focus on time risk and money. “These fundamental concepts shape our world,” explains Pete, who is a sought-after speaker for professional conferences, and is frequently quoted in national mainstream and trade publications.
After being asked too many times “What is an actuary, exactly?” Pete has written two books to answer another question: “How does an actuary think, and why does it matter?”
His first book, What’s Your Future Worth, is an accessible step-by-step guide to using the powerful concept of Present Value. Pete explains, “My goal is to help readers determine the value today of something that might happen in the future and evaluate outcomes that might arise from choosing one path instead of another.”
In his newest book, Money Mountaineering, Pete shares his views on the challenges we face to survive and thrive in a complex uncertain noisy and sometimes irrational wilderness. “I hope to help readers better understand the financial world they must live in and what they must do to make their way through it,” Pete shares.
Pete is also a senior consulting actuary for CapAcuity a member of the University of Illinois Academy for Home Equity in Financial Planning and the outside director at Rael & Letson. He is a longtime resident of Sana Rosa, CA. Learn more at www.peterneuwirth.com.