Is it Possible to Think your Way to Financial Success?

October 14, 2013

Think for a moment about how optimistic you are about your personal financial situation.  Are you confident that your financial life will improve over the next 12 months? Your response to these questions provides invaluable insight into your ability to achieve future financial success. 

During a recent series of our Ask-A-Planner sessions, I had the privilege to meet with employees whose company provided them with an opportunity to meet with a financial planner with no strings attached. Every session is as unique as the people that we meet with but we often see common themes and similarities.  That’s why I wasn’t overly surprised when two of my recent participants could have passed as identical twins based on their financial health.  However, further inquiry into their personality styles and the thoughts they shared about their financial futures quickly identified that these women in their late 50’s were indeed polar opposites.

So what was the key differentiator?  Despite similar net worth situations and similar concerns about the possibility of downsizing and early retirement packages at work, one remained optimistic about her financial life plan while the other appeared to be overcome by a wave of pessimism. This begs the question that is often up for a good debate. Does optimism help us or hold us back when it comes to reaching important financial life goals?

Despite continued economic concerns and fears of another significant downturn, we are generally a nation of optimists.  According to a recent Country Financial Security Index survey, optimism is on the rise since the height of the Great Recession.  On the surface, this may seem hard to believe with the talks of a looming retirement “crisis,” continued economic uncertainty, rising healthcare costs and concerns about Obamacare as well as the growing national debt crisis.  (My own optimistic outlook is challenged a bit when you look at the laundry list of internal and external forces that create obstacles for our personal finances.)

How does optimism impact our personal finances?

You may be thinking that this positive thinking stuff is great and all but can it really impact my life. A study conducted by researchers at Duke University specifically examined the role that optimism plays in our financial lives. They found that optimists tend to save more money, are more likely to pay their credit card balances on time, have a greater tendency to invest in stocks, work longer hours, and plan to retire later (or not at all) than less pessimists.  Hope and optimism are also associated with goal oriented behaviors such as financial planning.  If you are optimistic, there is good news – you are more likely than others to make smart financial decisions.  Regardless of your current financial state of affairs, this is a good sign if you are ready to take action and cash in on an optimistic outlook.

Too much of a good thing?

However, it’s quite possible that optimism only works in moderation and too much of it can actually create problems. Extreme optimists tend to work significantly fewer hours, hold a higher proportion of individual stocks, save less money than the national average, are more likely to carry a balance on credit cards, and have a greater tendency to assume too much investment risk. If you are extremely optimistic, you may also tend to have short planning horizons and act in ways that are generally not considered wise. This is kind of like taking a “just live in the moment, the future will take care of itself” mindset.

Furthermore, many optimists may approach financial setbacks (like the possibility of corporate downsizing or stock market losses) with an attitude that things will be better in the future.  At extreme levels, this attitude can lead to a sense of complacency and worse – procrastination.  Why worry about saving more today?  Why build up an emergency fund beyond the traditional 3-6 months worth of living expenses?

Much of this is related to the concept of “optimism bias.” In the world of behavioral finance, this refers to the tendency to be overly optimistic about the outcome of planned events.  This creates a paradox as we overestimate the possibility of a good outcome and underestimate the likelihood of bad events.  It also may explain why so many Americans took on more debt in the years leading up to the recent financial crisis.  It usually makes sense to temper optimism with a healthy dose of realism, establish a plan to achieve your goals, and prepare for potential setbacks with a sense of resiliency.

How about you? When it comes to your personal financial outlook are you a glass half full or glass half empty type of person?  Next week, we will explore the role that optimism can play in either helping or damaging your financial plans.