Christopher Booker, an English journalist and author, described wishful thinking as:
A pattern that recurs in personal lives, in politics, in history – and in storytelling. When we embark on a course of action which is unconsciously driven by wishful thinking, all may seem to go well for a time, in what may be called the “dream stage”. But because this make-believe can never be reconciled with reality, it leads to a “frustration stage” as things start to go wrong, prompting a more determined effort to keep the fantasy in being. As reality presses in, it leads to a “nightmare stage” as everything goes wrong, culminating in an “explosion into reality”, when the fantasy finally falls apart.
Edward Young, an English poet, summarized this concept more elegantly when he wrote:
All men think all men are mortal but themselves.
Our brains, through many millennia of evolution, have been hardwired to ensure we remain hopeful and resilient in the face of adversity. Thus, it shouldn’t be shocking that optimism is linked with success. For example, consider the tendency of men to overestimate their attractiveness. Since courtship has very little cost, it might have been advantageous for cavemen and cavewomen to overestimate themselves.
However, we can, and often do, take this too far. We overestimate our ability to predict the future. We assume desired events are more likely. We assume we have more control than we do. We buy lottery tickets. When it comes to important decisions, realism should probably outweigh optimism.
Dangers of optimism
Roger Lowenstein, in his book When Genius Failed, noted that:
There is nothing like success to blind one of the possibility of failure.
Overconfidence has a knack of turning a success story into a Greek tragedy. We would do better to recognize the limits of our understanding. For example, people tend to have an optimistic outlook when it comes to their health. They avoid going to the doctor or taking any preventative measures that would save them from future agony. People also assume they are less likely to be a victim of crime, and take unnecessary risks as a result.
The inverse is also true. People who have had a health scare or have been the victim of a crime may overestimate the future likelihood of undesirable events. This is pessimism bias, and it can be just as damaging as optimism bias.
Dr. Albert Schweitzer, a German philosopher, put it this way:
An optimist is a person who sees a green light everywhere, while the pessimist sees only the red stoplight. The truly wise person is colorblind.
When things do go wrong, we have a tendency to distort reality in order to feel better about the situation. We begin to only hear what we want to hear, and ignore all evidence to the contrary.
Wishful thinking is rooted in denial. Our strategy has failed up until now, but tomorrow everything is going to change. In startup cultures, this is referred to as failing to pivot. In a recent podcast, Mark Andreessen framed it this way:
When I was starting out, we didn’t have this word ‘pivot’, we didn’t have a fancy word for it, we just called it ‘a fuck up’.
You do see people who are determined and will just pound their heads against a wall for years and years. You admire them for their determination but at a certain point it just becomes obstinance.
We can convince ourselves of almost anything, however, simply refusing to see unpleasant facts wont make them go away. It is important that we don’t lie to ourselves.
As it relates to investing
When our investments do well, it is because of our superior insights. When our investments do poorly, it is just bad luck. We underestimate randomness, and often draw the wrong conclusions from our results. Warren Buffett puts it this way:
Any investor can chalk up large returns when stocks soar, as the did in 1997. In a bull market, one must avoid the error of the preening duck that quacks boastfully after a torrential rainstorm, thinking that its paddling skills have caused it to rise in a the world. A right-thinking duck would instead compare its position after the downpour to that of the other ducks on the pond.
We need to focus on knowing what we don’t know. What can go wrong and what are the consequences of that. Instead of blindly assuming the future holds positive outcomes, we need to demand a margin of safety in our decisions. Most importantly, we can’t lie to ourselves when things don’t go our way. This is how fraud is justified. People say their strategy will turn around if they are just given a little bit more time. They cook the books and in the end everything always blows up.
Wishful thinking is a double-edged sword. It encourages us to take risks that can improve our well-being but it also encourages to ignore risks can damage our well-being. Finding the right balance between the two, requires that we weigh the costs and benefits of being wrong. If there is little downside to assuming the best, we should probably assume the best. If there is existential downside to assuming the best, we should probably base our decisions on reality instead.