Planning Fallacy

The Planning Fallacy is a powerful Cognitive Bias that causes us to systematically underestimate the time, costs, and risks associated with a future task, while simultaneously overestimating its benefits. First identified by Nobel laureate Daniel Kahneman and his colleague Amos Tversky, this mental blind spot explains why your “quick” home renovation project takes three months longer and costs twice as much as you budgeted. It’s not just bad luck; it’s a feature of human psychology. We tend to focus on our specific, optimistic plan, imagining a smooth path to completion. We filter out the lessons from similar past projects, both our own and others', that were plagued by delays and unexpected problems. This tendency to take an overly optimistic “inside view” leads us to create plans that are best-case scenarios, which rarely, if ever, unfold in the real world. For investors, this bias can be financially devastating, leading to wildly unrealistic expectations about a company's growth, a project's profitability, or the time it will take for an investment thesis to play out.

The key to understanding and overcoming the planning fallacy lies in recognizing two distinct ways of forecasting the future. Our brains are hardwired to prefer the first, to our detriment.

This is our default, intuitive approach to planning. When we take the inside view, we focus narrowly on the specific details of our current project. We gather information that is close at hand, construct a compelling story of future success, and anchor our expectations on that optimistic scenario. An investor taking the inside view might say, “This company's management team is brilliant, and their new product is revolutionary! They project they'll capture 10% of the market in two years.” This view ignores the thousands of other companies with brilliant teams and revolutionary products that have tried and failed. It feels specific and insightful, but it's often a fantasy.

The outside view is the statistical and rational antidote. Instead of focusing on the specifics of our situation, we should deliberately ignore them and instead view the project as an instance of a larger reference class. This approach is also known as Reference Class Forecasting. The core question of the outside view is: What happened when other people tried to do this? Instead of listening to the CEO's projections, the outside-view investor asks, “Historically, what percentage of companies that launch a new product in this industry actually succeed in capturing a 10% market share within two years?” The answer, based on a broad dataset of similar cases, is almost always more pessimistic—and more accurate—than the rosy picture painted by the inside view.

The stock market is a minefield for those susceptible to the planning fallacy. Corporate managers are perpetually optimistic, and the stories they tell can be intoxicating.

Investors often fall in love with a company and expect its stock price to appreciate on an accelerated timeline. They model a best-case scenario for earnings growth or a corporate turnaround, assuming everything will go right. However, business is messy. A turnaround plan that looks perfect on a slide deck might take twice as long and be only half as successful in reality. The planning fallacy causes us to underestimate this operational friction and the time it takes for value to be recognized by the market.

Companies with a grand, world-changing vision are particularly dangerous. Investors get swept up in the compelling story—the inside view—of how a company will disrupt an entire industry. This is closely related to the Narrative Fallacy. They focus on the exciting potential and ignore the sobering outside view: the vast majority of startups fail, and very few companies ever achieve the level of dominance their founders promise. When the story is good enough, investors stop paying attention to the statistics.

A core tenet of Value Investing is to protect yourself from your own psychological flaws. Here are three powerful tools to combat the planning fallacy.

Make it a mandatory part of your investment checklist. Before you invest based on a company's planned factory expansion, merger, or product launch, find the base rate.

• What is the historical success rate for mergers of this size in this industry?
• What are the average cost and time overruns for similar large-scale capital projects?
• What percentage of drugs in Phase II trials actually make it to market?

This data provides a vital reality check against management's (and your own) optimistic forecasts.

Coined by Benjamin Graham, the Margin of Safety is your ultimate defense. By insisting on buying a business for a price significantly below your estimate of its Intrinsic Value, you create a buffer for error. You are implicitly acknowledging that things will probably go wrong. The future will likely be worse, more expensive, and slower than you plan. If the company's turnaround takes two years longer than expected, or if a project's costs balloon, a deep margin of safety can protect your principal and still allow for a satisfactory return.

This brilliant technique, developed by psychologist Gary Klein, flips planning on its head. Before finalizing an investment, conduct this thought experiment:

1. Imagine it's one year in the future, and the investment has been a complete disaster.
2. Now, take 10 minutes to write a story explaining exactly how and why it failed.

This exercise forces you to step outside the optimistic inside view and realistically consider the threats and obstacles. It might reveal weaknesses in your thesis that the planning fallacy had conveniently hidden from view.