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If you were an Econ (a totally rational person) you would be able to take all of the information that’s available to use and use that information to accurately forecast what’s going to happen in the future.  That might be true if all of us including you are able to keep your biases and feelings out of the way when making predictions about what’s going to happen in the future.

The truth is you’re not an econ and neither am I.  Both of us have this problem.  We are way too optimistic about what’s going to happen in the future.

My problem with budgeting.

When I had my food service company I would do an annual budget and every year that budget would be off by anywhere from 5% to 20%.  You might be thinking that I was incompetent with my ability to budget and you might be right about that.

At the same time, I just was over optimistic on what I thought we would do for sales every year.  I was pretty good with budgeting expenses.  I just was horrible at budgeting how much we would do in sales. 

At first, I thought this was something that only I had a problem with.  Then I started to observe others, both in business and in their personal life with annual budgets they did.  Lo and behold, I found that others were just as bad as I. 

It could be that we all were really bad at budgeting, but then I ran across the topic of behavioral economics.  I found that humans as a group are just over optimistic when it comes to believing what is going to happen in the future.

Let’s think about some of the reasons this might happen.

You really do think you know how to predict the future.

There have been way too many times where I was sure something was going to happen.  Sometimes it did but more often what I thought was going to happen in the future never came to be.  And, the worse part was I often would make plans based on what I was sure was going to happen and those plans at the very least made my life inconvenient for at least a little while.

I’m wondering whether this has ever happened with you.  If it has I’m sure you know exactly what I’m talking about.  And I’m sure it has happened to you.

Here’s what goes wrong when you are too confident.

If you’ve made commitments about what you think is going to happen in the future those things could come back and bite you and make your life uncomfortable.  Let’s take a look at some of the things that could get in your way:

  • You might have made a commitment for a great vacation based on a bonus that never got paid.
  • You might have decided to move to a more expensive house because you were sure you were going to get a big raise.
  • You might have made a commitment for a second home because you were sure your business would have a huge increase in profits.
  • You might have told your spouse that in the near future your economic future would be much better and instead of it getting better, it got worse and you know what sort of problems that caused.

If any of these things have ever happened to you, join the club.  Like almost every other human on the planet you were just too optimistic about what you thought was going to happen in the future.

A possible solution to being too optimistic.

The way I manage to not be too optimistic is by doing scenario planning.  This is where I make two to four different predictions for what could happen in the future.

Because I’m pretty optimistic I like to start with a good outcome.  After I’m done with that, I usually am feeling pretty good about myself.  I bet the same would be true for you.

I then go to the other side and build a scenario for what would happen if everything falls apart and my future is a lot worse than I thought.  This usually scares me and makes me think about what could happen if this scenario really happens.

Finally, I do what I call the realistic scenario.  This is where what probably will happen.

After I’ve done the three scenarios, I can be reasonably sure that what really happens will fall somewhere in between my three scenarios.  Most importantly, I can think about what I’m going to do if I start down the road towards any of the three, especially the worst case.  This is the one that can cause my and you some real pain.

Have a format for what you want to use to predict the future.

When I talk about doing scenario planning lots of times I’m told that it just takes too much work.  The only way it takes too much work is if you start from scratch every time you do a plan.  I recommend that you set up a template that you can use over and over.  That way doing a scenario will only take you a few minutes and you can see what different futures in your life might look like.

You might think this is for businesses only, but you would be wrong.

If you don’t own a business you could be thinking scenario planning is only for business owners.  If that was your thought, you would be wrong.  If you work for someone else, you have different outcomes that could happen in your life.  Make sure that you also plan for what your future might be.

This is especially true if you are planning for your retirement.  Do yourself a favor…….make sure you do alternate scenarios for what your retirement would look like at least five years before you decide to retire.  That way you can see if you’re on or off track for the type of retirement you want.

Why don’t you click here and let me know what you think about the planning you do in your life?  I’m interested to see if you think scenario planning has a place in your life.


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Topics: financial planning, scenario planning, behavioral economics

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