Overconfidence and calibration

In short

A friend of mine once told me he was ninety percent sure his business would break even by spring. It did not. Many of us are more certain than the facts allow, and it can cost real money. You can act on that today. Write down a guess before you make a money choice, and put a number on how sure you are. Then check the guess against what happens, and keep the score in a notebook. Give yourself a wider range than feels natural, because your first range is probably too narrow. Ask one honest friend what could go wrong before you commit.

The whole of it

What it is

I once watched a man at a county fair swear he could guess the weight of a hog within five pounds. He missed by forty. He laughed about it, and I liked him for that. He was not a fool. He was a person, and persons are sure of themselves in ways that the world does not always honor.

Overconfidence is the habit of believing you know more than you do. It shows up in three common ways. One is thinking you are better than others at a task. Another is thinking your estimate is more exact than it is. The third is being too sure the future will go your way. Researchers who study judgment have written about all three for decades, and Daniel Kahneman's book Thinking, Fast and Slow gives a plain account of them.

Calibration is the cure, and it is a simple idea. If you say you are ninety percent sure, you should be right about nine times in ten. If you are right only six times in ten, you are overconfident. If you are right nine times in ten when you said sixty percent, you are underconfident. Calibration means your feeling of certainty matches how often you turn out right.

You have probably felt that quiet pull toward being sure. It feels good. It feels like strength. But the strongest people I have known were the ones who could say, "I might be wrong about this."

How it works

If you are holding a money choice right now, your mind is working to make it feel settled. That is its job. It hunts for facts that agree with you and lets the others slip by. This is called confirmation bias, which is just the habit of noticing what supports your view.

Your mind also leans on what is easy to remember. If a stock tip worked out for a neighbor last year, that story sits close at hand. The dozen tips that failed sit somewhere in the back. So your sense of the odds gets bent by which stories you happen to recall.

Add one more thing. We tend to judge our plans from the inside. We picture the good path and skip the bumps. Kahneman and Amos Tversky called this the planning fallacy, and it helps explain why home projects run late and over budget. Say a repair that you think costs 4,000 dollars ends near 6,000 dollars. You did not lie to yourself on purpose. You just pictured the smooth version.

The cost in money terms is easy to see. An overconfident person may trade too often, and every trade has fees or tax costs. An overconfident person may save too little, sure that a raise or a windfall is coming. An overconfident person may skip insurance or an emergency fund, sure that trouble is for other people. None of that is wickedness. It is only hope, wearing a little too much starch.

The numbers, and where to find yours

Calibration lives in your own records, so the numbers that matter are yours. Still, a few outside figures can keep your guesses honest.

If you invest in a workplace plan, your yearly contribution limit is the current figure, which the official source publishes each year. Check that against what you plan to save, and write down whether you expect to hit it. The official source is the Internal Revenue Service, on its page about retirement plan contribution limits. Look there for the current figure and the date it was set.

If you keep an IRA, the yearly limit is the current figure, which the official source publishes each year. The same IRS page lists it. Guessing your limit from memory is a fine little test of calibration. Say how sure you are, then look it up and score yourself.

For your own spending, the best number is your actual monthly cost. Pull three months of bank statements. Add them up and divide by three. Many people are surprised, and being surprised is the whole lesson. The gap between what you guessed and what you found is your calibration gap.

A worked example

Let me tell you about a woman named Dana. She is thirty four and earns 52,000 dollars a year. Her employer matches 3 percent of her pay, so she gets an extra 1,560 dollars a year if she contributes at least that much herself. The math is 52,000 times 0.03, which is 1,560.

Dana told her sister she was "pretty sure" she spent about 3,000 dollars a month. She put it at eighty percent sure. Then she pulled three months of statements. They came to 3,300, 3,700, and 3,500 dollars. Add those and you get 10,500. Divide by three and you get 3,500 dollars a month.

So her guess was off by 500 dollars a month. Across twelve months that is 6,000 dollars a year she had not counted. That is nearly four times the size of her match.

Dana did not scold herself, and I admire that. She wrote in her notebook, "Said 80 percent sure, was wrong by 500." She made a rule. From then on, when she guessed a monthly cost, she added a cushion of ten percent and gave a range instead of one number. For groceries she used to say 400. Now she says 400 to 550, and she checks.

After six months she had scored twenty five guesses. She was right on nineteen of them when she gave herself a range. That was better than when she gave a single number. Her sister asked how she got so good. Dana said she just got humble about the small stuff, and the big stuff got easier.

Where it goes wrong

Now I should warn you about the other ditch. Some folks hear all this and swing too far. They become so unsure that they never act. They keep money in a drawer, or they wait for perfect information that never comes. That is its own kind of cost, because waiting has a price too.

Calibration is not doubt for its own sake. It is honest accounting of what you know. Sometimes the honest answer is that you are quite sure, and you have good reason. A person who has tracked their spending for two years can trust their monthly figure. Trust that.

Another trap is scoring yourself only when you lose. If you record your misses and forget your hits, your notebook will lie to you. Write down every guess, the good and the bad. Fair books make fair judges.

A third trap is asking advice only from people who agree with you. That is not a check. That is an echo. Pick someone kind but willing to say, "Have you thought about this?" Thank them when they do. Nobody enjoys hearing it. Everybody needs it.

And do not forget that your confidence can be fine while the plan is poor. Feeling sure and being right are cousins, not twins. If you want to test your guesses against real figures, your own bank and card statements are the surest place to start.

Questions to answer before you leave this page

What is one money guess you made this month, and how sure were you when you made it? Have you written that guess down anywhere, so you can check it later? When did you last look at three months of your real spending instead of trusting your memory? If you gave a range instead of a single number, how wide would it need to be to feel honest? Who is the one person you trust to tell you what might go wrong, and when will you ask them? And what would it feel like to be wrong, and be fine with it?