Our financial decisions are based on our expectations for the future.
We save for retirement because we expect we'll live a long time in old age, a period where we expect to be relatively unproductive. We invest in stocks because we expect the market to provide outsized returns when compared to other asset classes. We set aside emergency savings because we expect that bad things will happen — if not tomorrow, then next week (or next year).
We base our expectations on past experience — both our own experience and the experiences of others.
We expect to live a long time in old age because statistically most of our contemporaries live a long time in old age. We expect the stock market to provide excellent returns because for the past 100 years, that's what the stock market has done.We expect bad things to happen because bad things always happen.
Generally speaking, there's nothing wrong with this method of planning. It works.
When we base our expectations for the future based on what's happened in the past, we tend to get good results. We accumulate money for when we're no longer able (or willing) to work. Our investments grow. We have a cash cushion for when the car breaks down or little Jimmy breaks his leg.
Beyond All Expectations
But what happens when the old patterns break? What happens when past data becomes meaningless? That's the subject of an intersting article from Nick Maggiulli at Of Dollars and Data.
He tells the story of how the dodo went extinct. Evolving in an ecosystem without predators, these birds had no fear of humans. They had no expectation that another creature might hunt them down and eat them and end the species.
From the perspective of the dodo, the arrival of humans (or any other large predator) was outside the realm of its evolutionary grasp. Anything the dodo had approached previously had not tried to eat it. However, the arrival of humans broke the old pattern. It was beyond all expectations.
This idea is directly relevant to how investors use historical financial data to make decisions about the future. We assume that history is a great guide for what is to come, which is only sometimes true. We rely heavily on previous patterns…until they break. This is the classic black swan problem explained by Nassim Taleb, and highlights the difficulty with relying on financial history to make predictions.
“Just like the dodo,” Maggiuilli says, “investors are on their own island of financial history with no clue what will wash ashore from the seas of tomorrow.”
An Uncertain Future
I love Maggiulli's short article on expectations because it does a great job illustrating a point I try to make now and again.
Life would be easy if we could see the future. We'd know how to invest, how much to save for retirement (because we'd know how long we'd live), and whether or not to marry the gal we just met on Tinder.
Because we can't know the future, life is difficult. Decision-making is difficult. We make our best guess, but often we guess wrong. It's tough to plan for your future when you don't know what that future holds.
For one, the world around you is constantly changing. You may be sure of your current situation, but what will your life be like five years from now? Ten? Odds are you can't come close to making an accurate guess. (In some cases, it's tough to predict just one year out!)
For another, you change. As you grow and develop, your priorities and values grow and develop too. What made you happy in the past may not make you happy in the future.
Stumbling on Happiness
In 2006, Harvard psychology professor Daniel Gilbert published Stumbling on Happiness, a book about that explores this topic at length. In this presentation from the 2004 TED conference, Gilbert compresses his ideas into bite-sized pieces:
Gilbert says that because we can plan for the future, our preference is to structure our lives in such a way that we're happy both now and later. The problem is: We don't know what will make us happy in the future! In fact, Present You usually does a poor job of predicting what Future You will like.
Which future would you prefer? One in which you win the lottery? Or one in which you become paraplegic? Which would make you happier? […] A year after losing their legs, and a year after winning the lotto, lottery winners and paraplegics are equally happy with their lives.
The problem is impact bias, our tendency to overestimate the “hedonic impact” of future events. Put another way, the things that we think will make us happy usually don't make us as happy as we think they will. Winning the lottery isn't a panacea. Having an affair with your hot new co-worker won't be as thrilling as you think. And losing a leg isn't the end of the world.
Present You vs. Future You
How tough is it to predict your future path?
Here's a simple test: Think about where you were five years ago — where you lived, who you spent time with, what you did. How does that compare with where you live today, who you spend time with, and what you do with your time? Chances are your life today is different than it used to be — possibly much different than you might have predicted.
Here are two examples from my own life:
- When I was a junior in college, I expected to graduate, settle in a big city, get a job as a counselor or therapist, get married, have kids, and live happily ever after. I had no inkling that five years later I'd own a house in my hometown, work at the family business (something I swore I'd never do!) in a job I hated, and have over $20,000 in consumer debt. No inkling. (Only the “get married” part of my expectations proved to be correct.)
- Five years ago, I was newly divorced and had just begun dating. I lived in an apartment close to downtown Portland. I didn't want to own a house. I was obsessed with travel. I went to the gym several times each week and was in the best shape of my life. I had “retired” from writing about money — and thought that I would never return to the subject. Today, things are different. Kim and I have been together for 5-1/2 years. We own a home in the country, and we have three cats and a dog. Since returning from our 15-month RV trip, I haven't traveled much. My fitness is suffering because I'm not making the gym a priority. And, of course, I'm back to writing about money at Get Rich Slowly!
Sometimes your future life fails to live up to your expectations, and sometimes it exceeds them. But in nearly every instance, you cannot predict where life will take you. No wonder Present You often does such a poor job of setting things up for Future You.
Avoiding the Fate of the Dodo
When people get frustrated and panicked at unplanned events, it's often because they've built their life around certain expectations. They expected their marriage to last “forever”. They expected their job to be secure. They expected home values to continue soaring. And so on.
So, what can you do? How can you be certain that you and your lifestyle won't go the way of the dodo? Truthfully, you can't. There is no certainty in life.
What you can do, however, is develop the skills needed to cope with this uncertainty.
- Know your purpose. I know I've flogged this dead horse repeatedly over the past couple of years, but that's because I believe it's important. When you're clear on your purpose in life, when you have a personal mission statement, then it's easier to cope with unexpected events. When something bad happens, you're able to respond more effectively because you know what it is you want out of life.
- Be adaptable. If you're too rigid in your thinking — in your expectations, habits, and attitudes — then it's very difficult to compensate when something goes wrong. Develop resilience — financial and otherwise. Your ability and willingness to adapt is a barometer that measures both your ability to thrive and your capacity for happiness.
- Worry more about what you do than what you get. Over the years, I've noticed that too many people fixate on desired results. They're overly obsessed with an outcome — whether that's getting out of debt, achieving financial independence, or getting a certain job — instead of focusing on the process. Here's the thing: You cannot control outcomes. You can only control your effort. If you focus outcome instead of effort, you're setting yourself up for a lifetime of disappointment.
- Expect the best — but prepare for the worst. Although this entire article has been about the problem with expectations, I'm not going to tell you that you shouldn't have them. But I want you to be deliberately conscious of these expectations, to know what they are and why you have them. Then, most important of all, after you've identified your expectations, take some time to figure out what you'll do if these expectations are not met. What are your contingency plans? What will you do if the stock market crashes? If you lose your job? If your partner dies tomorrow?
Despite the problems inherent with basing your expectations for the future on past experience, there's really nothing better to go on. When we make plans for the future, our best bet is to base those plans on what has happened in the past. No other method provides better results.
But it's important that we recognize that the past is not a roadmap. It can't tell you what lies ahead. All it can do is to help you see what other roads have been like, how other people have navigated through life.
Maybe that's the key to avoiding the fate of the dodo: Instead of having a set of expectations for the future, have a set of plans. And be willing to revise those plans when things change. Because trust me: Things are going to change.
Author: J.D. Roth
In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.