One spring day in 1995, a fellow named McArthur Wheeler walked into two banks near his home in Pittsburgh and robbed them at gunpoint.
He almost got away with it—except for one critical flaw in his plan: The disguise he chose didn’t disguise his face at all. Instead of the usual stocking cap or hat-and-sunglasses, Wheeler made an unconventional choice: He applied just a coating of lemon juice to his face. His reasoning: Knowing that lemon juice could be used to make invisible ink, Wheeler figured it would have the same effect on his face, making it invisible to surveillance cameras.
Because he was so easily identified, Wheeler was arrested just hours later. As police led him away, Wheeler sighed in disbelief. “But I wore the juice,” he said.
Wheeler’s case is so famously absurd that it was later featured in an academic article on the topic of incompetence: “Unskilled and Unaware of It” by David Dunning and Justin Kruger. Their insight was that people are often poor judges of their own competence. Worse yet, we often get it exactly wrong: Incompetent people think they are more competent than they actually are, and highly competent people tend to underestimate their skills.
While McArthur Wheeler is in a class by himself, Dunning and Kruger’s research does carry an important message: Over-confidence can be a big problem, especially when it comes to the world of investments, where there is as much noise as there is data and there’s such a strong temptation to predict what’s going to happen next. After all, the hard part about financial planning isn’t the math; it’s the uncertainty.
What can you do to navigate this uncertainty? Here are three suggestions:
1. Set a course then stay the course. At its core, financial planning is simple: You have a set of financial goals, and you want to be sure you’re saving enough to reach those goals. But with the stock market’s regular ups and downs, it’s easy to get distracted. In fact, there are people whose job it is to distract you. From TV to newspapers to social media, Wall Street “strategists” are all around us, dissecting and pontificating on the latest financial news. Last week they were talking about interest rates. This week they’re talking about China, and next week they’ll be on to some new topic. My advice: Tune them out. Remember that those strategists work for brokerage firms, and their goal is to get you to tinker with your portfolio, which generates trading commissions for them. Instead, you want to act like a racehorse wearing blinders. Focus straight ahead on your goals, and never let the sideshow of the week distract you from your plan.
2. Avoid big bets. In promoting index funds, the late Jack Bogle, founder of Vanguard, often talked about “the relentless rules of humble arithmetic.” Indexing worked, he said, because it kept costs low. I completely agree with that, but that’s not the only reason indexing has produced better results than active management. Another reason is that active managers can make risky, outsized bets in ways that index funds cannot. A case in point is former star fund manager Bill Miller, whose flagship fund once beat the S&P 500 for an astounding 15 years in a row. During the 2008 financial crisis, however, Miller badly miscalculated. He thought people were overreacting and that the crisis would soon pass. This led him to double down on the stocks of AIG, Bear Stearns and other financial firms that lost nearly all their value. His fund was decimated, and Miller was soon out of a job. When you invest in a broadly-diversified index fund, however, you avoid that risk. While you do give up the opportunity to outperform the index, you are simultaneously buying yourself the peace of mind that you won’t dramatically underperform when a fund manager’s overconfidence gets the better of him.
3. Plan for a different tomorrow. As human beings, we have a limited ability to process data, and these limitations bias the way we think about things. Notably, a phenomenon called Recency Bias leads us to place disproportionate weight on recent events and to discount events that happened longer ago. The result is that we generally assume things will continue tomorrow the way they’ve been going today and don’t consider the possibility of extreme change. This is a problem because, of course, things do change. This is where it’s important to avoid being over-confident. In recent years, the stock market has delivered steady positive gains while interest rates, inflation and tax rates have all been near historic lows. While that’s all been very positive, it can and probably will change at some point. That’s why I always recommend considering, and planning for, a variety of scenarios other than the status quo. You can’t prepare for everything, but as you formulate your financial plan, it’s worth considering a tomorrow that looks a good bit different from today.