A couple of weeks ago, I discussed the important role that our thoughts and beliefs can play when it comes to working toward important financial goals. While an optimistic outlook is associated with many positive outcomes related to our health and wealth, as with most things in life, moderation is the key when it comes to optimism related to our personal finances. Here are some questions to help determine if your optimism is helping or hurting your personal finances:
Do you do have a long-term financial plan? A solid financial plan strikes a balance between living in the moment and planning for future goals. If you are an extreme optimist, your planning horizon may be shorter than it needs be. You may even avoid planning altogether or simply procrastinate if you have an overly optimistic belief that all is well and the future will take care of yourself. If you are too pessimistic about your financial future, this can also lead to inertia and an unhealthy mindset that no matter what you do, your financial well-being will never improve.
Are you saving enough for retirement? Overconfidence can be an enemy to retirement planners. More people are indicating they plan on working longer, but the reality is that the job may not still be there or health problems may interfere with their ability to work longer. The best strategy is to save as much as you can in tax-advantaged accounts (401ks, IRAs, and Roth IRAs) and get into the game as early as possible.
Ideally, most financial planners recommend setting aside between 10-15% of your current income into retirement plans such as a 401k. If you are young and have some legitimate concerns about Social Security, you may need to even raise this target savings rate somewhat. Not able to get there immediately? Work up to your desired contribution amount gradually and take advantage of auto-escalation features within your 401k plan if available or give your retirement account a raise each year of at least 2% of your income. It also helps to actually run a retirement income projection to see where you currently stand. Don’t be one of the many overly optimistic people that fail take this important financial planning step.
Are you prepared for emergencies? An extremely optimistic person doesn’t need an emergency fund…right? The reality is that Murphy’s Law dictates that if something can go wrong, it will. I know this is not the most “optimistic” view of things but we have to be prepared for the unknowns in our financial lives that can seriously derail our short and long-term goals.
So how much is really enough? Well, this really depends on your personal situation and the stability of your future income as well as the potential risks for needing the money. Most financial planners recommend having at least 3-6 months of basic living expenses in a separate account. However, in many households the recommended amount could be as high as 6-12 months of savings for emergencies. The key takeaway here is regardless of how positive your outlook for the future may be, it is necessary to save and prepare for the unexpected. To take this mindset a step further, be sure to review life insurance and estate planning documents (e.g., wills, advanced health care directives, durable power of attorney) as well.
Are you investing too aggressively? Most of us recognize the importance of diversification but it is easy to forget that it consists of two parts. The first is diversifying between asset classes, which means having a mix of stocks, bonds, cash, and perhaps some alternative investments like real estate and commodities that matches your goals and tolerance for risk. The second important part of diversification is diversifying within an asset class. The biggest mistake an extreme optimist can make here is having too much (more than 10-15% of their portfolio) in a single stock (including company stock). If you have more than 10% of your investment portfolio in an individual stock holding, your portfolio may be at risk for increased volatility.
Optimism is more than just taking a glass is half full approach to our personal outlook on life. If you are optimistic about your financial future, it should help to remember that you can use this strength to your advantage and avoid the potential dangers of extreme optimism regarding financial matters. In contrast, pessimists believe that financial difficulties will go on forever and nothing can be done to change or influence life events. It’s kind of hard to succeed with a financial plan if it is doomed from the start.
What can you do if you are not feeling too optimistic about your financial future? As demonstrated in Learned Optimism by Dr. Martin Seligman, the good news is that optimism can be learned and you have the ability to change the way you view successes and setbacks in life. Sometimes developing new ways of thinking about our finances helps put financial plans into action. A healthy dose of optimism may just be what the doctor ordered if you’re looking to make significant progress in your financial life plan.