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May 2, 2019

The Financial Planning Risks of Over- or Under-Confidence

by Jason Heath

Jason HeathConfidence is an important character trait. In a financial context, neither too much nor too little is optimal, as both can lead to misjudging our planning and decisions.

When we are overly optimistic, we may anticipate future results that are better than likely. This can lead to risky decision-making and a failure to have contingency plans.

When we are overly pessimistic, there can be other risks. While there may no such thing as universal equilibrium, a balanced assessment of the risks of over- and under-confidence may help us critically assess our own personal financial planning confidence level.


There may be no better example of the extremities of confidence than investing. Some investors have no appetite for risk, while others engage in speculative behaviour. Both can be to our detriment.

The risk of taking too little risk is stark. Over a 30-year period, someone earning a 6 per cent annual return would need to save $11,933 each year to have $1,000,000 after 30 years. A more conservative investor earning 3 per cent annually would need to increase their savings by 71 per cent to $20,407 per year to reach the same goal.

The risk of taking on too much risk can also be precarious. The stock market volatility of the past year helps remind people of their true tolerance for risk. It is easier to be an aggressive investor in a bull market than in a volatile or bear market. Stock market losses are only temporary until we sell and make them permanent.

Pan and Statman (2012) found that investors are highly susceptible to recent stock market performance. “High past stock returns induce investors to invest in financial markets, whereas low past returns induce them to shy away from investing.”

The investors in the study were found to change their risk tolerance following a 6-month period of high or low returns, succumbing to exuberance or fear. Broadly speaking, investors may be tempted to buy high and sell low, contrary to the approach that a constant asset allocation and systematic rebalancing would suggest. This risk may be elevated today given the increase in do-it-yourself investing in recent years.

Despite the bad year for stock markets last year, it is important to remember the Toronto Stock Exchange returned 9 per cent in 2017 and 21 per cent in 2016. Did you sell stocks to rebalance in 2017 or 2016, or did you sell stocks out of fear in 2018?

Inappropriate risk tolerance and market timing aside, one of the most profound investing confidence errors relates to future return expectations. A September 2018 Natixis survey found that Canadian investors expect they will need a return of 9.1 per cent per year above inflation to reach their investment goals. The best-performing stock index historically, the S&P 500, has returned only 6.9 per cent annualized in excess of inflation since 1871. Since most investors are not invested 100 per cent in stocks, a long-term real return of 2 to 4 per cent over inflation may be a more reasonable expectation for an investment portfolio, depending upon the asset allocation and fees.


A recent National Bureau of Economic Research paper entitled Saving Regret sought to identify why people aged 60 to 79 had not saved more during their working years. Interestingly, it was not procrastination or poor investment returns, but economic shocks that most often led to insufficient savings. Job loss and health issues were the primary shocks identified.

Labour market risk is a tangible financial planning risk. Losing your job can result in a reduction in family income, lost benefits, and decrease in future retirement income.

Given how few people have an emergency fund, and how many are at risk from an increase in interest rates or drop in real estate prices, unemployment could pose a huge problem for susceptible Canadians. It has also been 10 years since the last recession. So, while the economy, real estate prices, and variable interest rates have bolstered the confidence of many Canadians over the past decade, this causes a complacency that sometimes only a correction can mitigate.

The impact of unemployment is magnified for those within 10 years of retirement, given this is when many people may be able to ramp up retirement savings. Incomes tend to be highest late in one’s career, and expenses for children or a mortgage tend to decline. A late career job loss could be very difficult if a similar level of income replacement is not possible. This is a good reason to plan to retire by 55 or 60, but to choose to work later.


Disability risk should also be a consideration. One-third of Canadians will have a disability of more than 90 days during their careers according to Statistics Canada. Despite this, Canadians remain over-confident – not only about the likelihood of a disability occurring, but also their ability to avoid the occurrence and the consequences.

According to Royal Bank of Canada (RBC), less than 10 per cent of disabilities are caused by accidents. “There is a mistaken perception that disabilities tend to be catastrophic in nature – caused by one-time, traumatic events. Most Canadians don’t recognize that common, chronic conditions such as mental illness cause the majority of disabilities,” according to RBC’s Mark Hardy.

Currently, an estimated 6 in 10 Canadians are covered by disability insurance. This means more than one-third of Canadians may be taking on considerable disability risk that they could or should insure against. Over-confidence in our ability to not only avoid disability, but to do so by simply being more careful, can increase the likelihood of a health issue causing a saving regret later in retirement.

High-income earners are particularly at risk given group disability insurance often has limits not only on the monthly disability insurance benefits payable, but also strict requirements about whether payments continue after the first two years of disability.

Life Expectancy

Young people are more inclined to be over-confident about their immortality. Only an estimated 3 in 10 Canadians aged 35 to 54 have a will, despite many not only having minor children, but also being divorced or common law and in situations that would make dying without a will more complicated.

Older Canadians may underestimate life expectancy. This lack of confidence may be in part because typical life expectancies that are quoted are the age at which the average person dies, currently 82 in Canada.

For someone who has already lived to 65, life expectancy from that point forward is much older than 82. In fact, there is a 50 per cent chance of a 65-year old man reaching age 89 and a 65-year old woman reaching 91. For a husband and wife, both aged 65, there is a 50 per cent chance of one of them living to 94.

Canadian retirees often make an odd pension decision that involves both over- and under-confidence in life expectancy. The Canada Pension Plan (CPP) and Old Age Security (OAS) pensions can both be deferred as late as 70. CPP can start as early as 60 and OAS can start as early as 65.

Most Canadians start their pensions early, and only an estimated 1 per cent defer them until 70. CPP and OAS deferral after 65 results in these pensions being increased by 8.4 per cent and 7.2 per cent per year respectively, plus inflation. If a pensioner expects to live into their 80s, they may be better off deferring their government pensions until 70.

While there may be other reasons that Canadians start their government pensions early —such as a lack of knowledge about the ability to defer— it is more likely a fear of drawing down on investments that triggers the decision to begin government pension income.

It is a contrarian decision. A fear of drawing down on investments suggests a lack of confidence that the investments will outlive them. However, if concerned about insuring against the risk of living a long time, the better decision may be deferring government-guaranteed, inflation-protected pension income that will live on to 110, so long as we do.


Confidence is a multi-faceted feeling. Finance tends to be black and white, with a focus on numbers and data. The impact of confidence on financial planning, both over- and under-confidence, can lead to decision-making that compromises financial goals.

It is important to understand the risks of over- and under-confidence in financial planning. More than anything, it is important to assess how the confidence we have impacts our own personal financial decisions.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.