A Step-by-Step Guide for Cultivating Optimism in Your Financial Life (Even if Your a Pessimist)
A deep dive on the science of financial optimism
Cultivating financial optimism is more than a mindset; it's a strategy for a happy, productive life.
This is the second entry in a 6-part mini-series on how to adopt a long-term money mindset.
In part one, I highlighted the many benefits of thinking in the long run and reviewed research on five traits found to help people adopt this mindset:
Confidence about the future.
Tendency to plan ahead.
Consistency in carrying out plans.
Completing tasks.
General thinking about future possibilities.
In this series, we're taking a deep dive into each trait, starting with confidence about the future—also known as optimism.
Confidence in the future=Optimism
Optimism, at its simplest, is having generally positive expectations about future events.
For our purposes, optimism and confidence about the future are interchangeable terms. I prefer 'optimism' for its specificity, but ultimately, they lead to the same outcome.
Keep that in mind as we discuss how optimism impacts your financial life.
Now, Let’s dive into the research.
A simple way to measure optimism
A 2007 paper by Manju Puri and David Robinson answered the question of whether optimists are better with money than pessimists.
One of the issues with researching this type of research is that you need a very clear definition of a fairly subjective term.
How did Puri and Robinson define optimism?
Simple.
They asked people how long they expected to live.
They compared their answer to the average life expectancy of someone of their age, ethnicity, current health status, and lifestyle.
An optimist is someone who expects to live longer than their actual life expectancy. That’s about as positive as one can be about future events.
The next problem in the context of financial research is whether this definition applies to financial situations.
They found that those who met their definition of optimism were more likely to have positive future expectations about the economy and that their income is likely to grow over the next five years—even when controlling for past income growth.
So, those who are optimistic about their life expectancy are also optimistic about the economy and their place in it.
How Optimism Impacts Financial Behavior
Puri and Robinson's study explored optimism's effect on three major financial life decisions: retirement planning, career choices, and investing.
Optimists in Career and Retirement
The study found that optimists work longer hours, anticipate extended careers, and are less likely to retire early. This trend persists even after accounting for demographics, health, and employment status. The paper suggests that optimists might overestimate the benefits of their labor, expecting that extra work will lead to promotions or other rewards.
How Optimists Save and Invest
Optimists tend to save more and are more inclined to pick individual stocks, though they do not necessarily lean more towards riskier assets like stocks over safer ones like bonds.
Interestingly, their asset allocation tends to be reasonably balanced between stocks and bonds, but they often believe they can outperform the market through stock-picking. Which long-time readers know usually ends badly.
Moderate vs. Extreme Optimists
Puri and Robinson divided optimists into two categories: moderate and extreme. Moderate optimists exhibit practical financial habits: timely credit card payments, long-term planning, and a belief in the virtue of saving. They tend to avoid irrational investment choices.
In contrast, extreme optimists—the top 5% most optimistic—display short planning horizons and a lesser inclination to save. Their financial behavior is often marked by overconfidence, impacting work, saving habits, and investment choices.
Another quote from the paper describes moderate optimists.
“Moderate optimists display prudent financial habits: they are more likely to pay their credit card balances on time, they have long planning horizons, and they report that they save because saving is a good thing to do.”
They also found that moderate optimists were the hardest workers by a comfortable margin and were much less likely to engage in irrational investing choices like day trading and picking individual stocks.
They found moderate optimists to be the best money managers.
The takeaway
Like all things with money and life, the key takeaway about optimism seems to be that a balanced approach is best.
You need to be optimistic to be a great money manager, but you also need to think rationally and not overestimate your own abilities.
The moderate optimist is hopeful for the future but knows what is within their control. That’s why they work hard and save more money. But they also know what they can’t control, like what happens in the stock market.
Now, let’s discuss how you can become more optimistic.