From Jonah Lehrer:

I’m pretty fascinated by this chart from the McKinsey Quarterly, which is a great demonstration of the optimism bias. The chart captures the earnings estimates of equity analysts for S&P 500 companies. The downward slope of these yellow lines is what happens when our hopeful projections meet dismal reality:

Unfortunately, all that data is no match for a deep-seated bias, which leads us to accentuate the positive and downplay the prospect of potential losses. (This helps explain why earnings projections are even less accurate during economic downturns.)

The graph above is beautiful in how it illustrates the problem of rose colored glasses in business. One commenter suggested: “This has nothing to do with optimism. Equity analysts are just cheerleaders for the companies they cover, so that their banks can get investment banking business. If the analysts started becoming pessimists, the banks would get no deals.”

Related to optimism bias in my mind is the notion that you would do better to invest “smarter” than to do so conservatively or realistically.

Ramit Sethi has written on this, discussing mutual funds v. index funds (active management, high fees, but sexy, v. automated management, low fees, but boring). As with the downward slope of earnings estimates, Ramit points out the insane fact that some 85 percent of mutual funds fail to beat the market!

Yet more people will invest in mutual funds than index funds this year because they believe, unrealistically, that they can find the “right” manager or the “right” funds, rather than trust an indexing process that delivers consistent returns.