Do you have enough money set aside to meet contingencies such as medical emergencies or temporary loss of income? Most individuals believe that a small amount, if at all, is enough to meet such emergencies. Why are individuals not keen on keeping enough emergency money?
Take the recent hurricane that hit the east coast of the US. Many residents in the area did not take enough precautions despite receiving an early warning. Some were reported as saying that they will never lose electricity because they had never lost power in the past.
Such behaviour can be related to the black swan event. That is, just because an event has not happened in the past does not mean it cannot happen in the future. The term “black swan” was first used by John Stuart Mill, a British philosopher and economist. What does the term mean?
You know that swans are white. Yet you cannot conclude that all swans are white, even if you saw millions of them. But suppose you spot one black swan. And yes, you can spot such swans in Australia. You can conclude that not all swans are white. Stuart Mill used “black swan” argument to discuss how an assertion can be rendered false by observation.
Nicholas Taleb used the term to argue that the financial markets were riddled with events that you did not see (like the black swan), but existed. Like the market crash that was waiting to happen… and did in 2008.
Your belief about emergency funds could work on the same level… a black swan event. That is, you may not see the need for such money now because you have not faced an emergency yet. The problem with such event is that its occurrence is typically underestimated.
optimism bias
Psychologists attribute such behaviour to optimism bias. This refers to the bias that causes individuals to believe that the chances of a negative event happening to them are less compared to the event happening to others. A smoker, for instance, believes that he or she is less at risk of developing smoking-related disease compared to others who smoke.
Likewise, some individuals do see the rationale in others creating an emergency fund. But such individuals may not yet have a fund themselves because they do not see an emergency happening to them. Such belief typically occurs from faulty thinking. And such thinking can be altered when they see an emergency happening to the people they know. Some act immediately thereafter and set up an emergency fund. Others do not.
(The author is the founder of Navera Consulting. Feedback can be sent to >knowledge@thehindu.co.in )