Monday, September 20, 2010

Looking on the bright side

In Why We Make Mistakes, I talk quite a bit about our tendency not only to err, but to err in a particular (and predictable) direction -- and that direction is toward optimism.

Many people see nothing wrong with this. From the time we are children, most of us are told to look on the bright side, to think positively. Which is fine, as far as it goes. But later in life, this trait usually becomes so ingrained that it forms a cognitive bias that can lead to a number of mistakes.

Here are two interesting and seemingly unrelated examples: one involves pensions; the other involves sex. We'll take sex first:

A few weeks ago the New York Times ran a front-page story on a birth control pill named ella (with a lower-case e). Ella is a so-called "morning after" pill, an emergency contraceptive designed to be taken after sex.

If you're a pharmaceutical company, you might think there's a big market for such a drug. After all, unprotected sex happens quite a lot: studies have shown that more than one million women who do not want to get pregnant are estimated to have unprotected sex every night in the United States.

But think again: According to the Times, many women who have unprotected sex tend to look on the bright side -- they think they won't get pregnant.

To quote from the Times: "Studies have found that many women fail to realize they are at risk for an unplanned pregnancy after unprotected sex." Which is is astonishing, given that half of all pregnancies in the United States are unintended.

Nevertheless, sayeth the Times, "they tend not to use the emergency contraceptives even when they receive them free."

In fact, says Dr. James Trussell, director of the Office of Population Research at Princeton, “Emergency contraception has no effect on pregnancy rates or abortion rates. Women just don’t use them enough to make an impact.”

No effect.

So, so much for a pill called ella. Now for pensions. It turns out that pension managers (at least those who manage public pension funds) have a lot in common with the morning-after crowd: They tend to look on the bright side. Which may not be so good if you happen to be relying on them for your pension.

According to The Wall Street Journal, pension managers are clinging to wildly unrealistic estimates of their funds' rate of return. And are those estimates unrealistically low? No, they are unrealistically high. The median expected return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators is a whopping 8%. That's the same as it was back in 2001.

For handy comparison purposes, a conservative investment like the 10-year U.S. Treasury note currently yields less than 3%.

If the funds don't earn 8%, of course, that means funding gaps down the road; the pensions won't have as much money as they thought they would have to pay retirees. And that's bad news if you happen to be a retiree.

So there you have it: sex, money and optimism all rolled into one.

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