How mars can teach us about our own finance universe
When it comes to personal finance, we’re usually advised to keep a little distance, figuratively, from our financial assets. This time let’s get an overview – literally. We can learn a lot from NASA and the setbacks it faces as it tries to bring its Martian samples back to Earth. It’s a perfect example of the kind of planning fallacy that can affect our reasoning on the timelines, costs, risks, and benefits of our financial decisions.
Investment advisor at Societe Generale Private Banking.
Are we really smarter than a rocket scientist?
A few short weeks ago, the US National Aeronautics and Space Administration (NASA) announced it would1 “seek innovative designs that will lower cost [and] risk” to transport the rocks sampled from Mars back to Earth. This came after an independent audit found that NASA had “[u]nrealistic budget and schedule expectations from the beginning”. This amounts to a doubling of costs, which are expected to ultimately reach $11 billion, and an arrival date closer to 2040 than 2030! Variances of over $5 billion, and an extra ten years, amount to quite a dilemma!
And yet, in our regular forecasts, can we really be more accurate than these world-class engineers working for a rigorous scientific organisation? The answer lies in our own behaviour. Are we last-minute Christmas shoppers? Do we leave paperwork until it’s down to the wire? Do our home improvement projects drag on and on? Maybe we underestimate holiday budgets or drive times, let alone the spiralling costs and delays in building or IT projects or business ventures.
NASA’s troubles may be in today’s headlines, but this kind of planning fallacy was spotlighted as far back as 1977, by researchers Amos Tversky and Daniel Kahneman2. They found that people looking to forecast deadlines tend to go with their gut – but that our intuition is often wrong. By systematically repeating those errors, they concluded that cognitive bias existed, but did not solidify their findings with experiments. Those were conducted later, as in 19943 when psychology students had to estimate the time needed to finish their thesis. While the majority of students took 55.5 days (with just 30% meeting the anticipated deadline), they had predicted, on average, 33.9 days, 27.4 days “if everything went as well as it possibly could” and 48.6 days “if everything went as poorly as it possibly could”.
The initial definition of the planning fallacy was expanded in 2003 (by Daniel Kahneman and Dan Lovallo4) to include underestimating the costs and risks of decisions and overestimating their benefits. Those errors are based on different mechanisms like optimism bias, overconfidence and forgetting previous experience.
From Martian rocks to the cornerstones of our decisions
Since anticipation is a cornerstone of our personal finances, they can be severely impacted by planning fallacy. For example, the consequences can show up when setting up or selling a business, running a construction project, relocating internationally, or comprehensively restructuring your financial assets.
The planning fallacy can cause unexpected delays that may jeopardise some key deadlines (e.g. fiscal year end, capital gain or loss offsets, etc.), the speed of ROI, or even the success of the financial transaction. Likewise, this bias can cause budget overruns, leading us to question the financial rationale of an operation or investment.
The planning fallacy, then, affects both i) the yield component of a project, by undervaluing the investment required and overestimating the profits and execution speed, and ii) the risk component by undervaluing it.
You can set up a few safeguards to shield you from this bias:
Be sure to view things from a distance: the planning fallacy can also cause us to overestimate the time and budget a third party will spend on their tasks. Of course, this is an effective way to balance out our overconfidence in ourselves!
If you have a decision approaching, break it down into several tasks to help you accurately calculate implementation costs and timelines.
Include your worst-case scenario: in the study mentioned above, the timeline in the worst of cases still didn’t go far enough!
For anyone who might have misjudged the time that went into writing this, the content is reassuring – a NASA engineer couldn’t have come closer!
1 https://www.nasa.gov/news-release/nasa-sets-path-to-return-mars-samples-seeks-innovative-designs/
2 “Intuitive prediction: Biases and corrective procedures”; Tversky, A. and D. Kahneman; 1977
3 “Exploring the ‘planning fallacy’: Why people underestimate their task completion times”; Buehler, R., D. Griffin and M. Ross; 1994.
4 “Delusions of Success: How Optimism Undermines Executives’ Decisions (hbr.org)”; Kahneman, D. and D. Lovallo; 2003
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