I recently met a four-star general. He one of the most interesting people I’ve ever met, but instead of talking about himself he took a sincere interest in everyone around him. A self-described “econ-nerd”, he asked me many questions about my work helping people invest for retirement. I explained my frustration:
“You can describe risk to people in simple terms they understand, but they still don’t really get it. For example: You can ensure a particular income level in retirement, with high certainty, if you reduce risk. People say they want this certainty—except when the stock market goes up and they feel they missed out. They still don’t get that the upside of risk comes at a cost.”
The general nodded and said:
“It’s the same thing planning a military operation. You explain to the politician in charge that there’s an objective and ensuring its success will require the following resources. Or we can do it cheaper, but there’s a higher probability of things going wrong. They always go with the cheaper option and then get upset when things go wrong.”
What hope do we have to make good financial decisions if even the smartest people running our country—when there’s more at stake than money—don’t fully comprehend basic risk concepts either? Even when we are educated, behavioral economics explains why we still make bad choices.