Are You Too Optimistic or Too Pessimistic with Your Financial Plans?
Individuals tend to have a natural bias toward optimism or pessimism. Experts believe that this bias is about 25% genetic but heavily influenced by your upbringing, relationships, and ease of schooling and other early successes and failures. It is also determined by age. A study found that optimism generally increases throughout younger adulthood, flattens out between ages 55 and 70 and then slowly decreases again after that. (Yes, it coincides roughly with the ages when you are happiest.)
No matter how you got to be the way you are, it is important to understand how your biases can impact your financial plans and therefore your future.
Are You an Optimist or a Pessimist?
So, are you an optimist or a pessimist?
Dr. Martin Seligman, a noted psychologist and professor of psychology at the University of Pennsylvania, defines the thinking styles of optimists and pessimists in terms of how someone reacts when something bad happens:
Optimists: Optimists think that a negative situation will only last a short period of time, is particular to the situation at hand (not a universal truth), and has little to do with their own character or skills.
Pessimists: Pessimists believe that bad situations are more permanent and pervasive — that whatever has happened will last and is global in nature. They also tend to feel a sense of responsibility.
So, how do you react to bad situations? The reality is that most people can be either optimistic or pessimistic depending on the precise circumstances.
Curious how you might be objectively measured as an optimist or pessimist? Try these tests:
- Life Orientation Test (LOT-R): Developed by psychologist Michael Scheier, the LOT-R test is a 10 item quiz that measures how optimistic or pessimistic you are about the future.
- Success Scale: Developed by Michelle Gielan, the Success Scale tests you for work optimism, positive engagement and support provision.
- Optimism Quotient: A quick and simple 10 question test.
Optimism, Pessimism and Your Financial Plans
Your bias toward optimism or pessimism can have a huge impact on your financial outcomes in life and especially retirement.
A lively discussion in the NewRetirement Facebook group revealed how overly negative and positive biases can have a dramatic impact on retirement outcomes.
And, there is a feeling that perhaps financial services companies and even the press overemphasize doom and gloom when it comes to the financial outlooks of some people.
If you have very conservative (negative) financial assumptions, then the math will say that you need a lot more savings to retire securely and that you will need to be very wary about your spending. If your assumptions are rosier, then the projections will lead you to believe that you can retire earlier and spend more.
The reality is that:
- Many people retire late, are thrifty and end up with more in the bank when they die than they had when they started retirement.
- Others run through their savings – be it thousands or millions – and live their last years meagerly.
- And, some get the balance just right. They live the life they want and achieve their financial goals.
How to Combat Your Bias for Better Financial Outcomes
Depending on your level of self awareness, you may not even know whether your are overly optimistic or pessimistic about your financial future.
It might be useful for you to evaluate your current financial plans and run a very worst case scenario and a very best case scenario. The NewRetirement Planner makes it easy. You will want to consider:
- Investment returns
- Unexpected expenses and possible windfalls,
- Housing appreciation
- Possible long term care need
- The value of your time
- How and with whom you want to spend your time
Consider which scenario makes you more uncomfortable and why. These feelings may reveal biases you weren’t aware of.
Overall, the exercise will probably help you feel more confident that you can weather whatever may happen. And, you may discover that you want to re evaluate your baseline assumptions or create additional contingencies .
There are certainly benefits to being pessimistic — back up plans are a key to success.
However, optimists – realistic optimists – tend to have better outcomes overall.
- Live longer
- Do better at reaching goals
- Are healthier
- Eat better
- Experience less negative impacts from stress
- Enjoy stronger relationships
Being an optimist can be particularly beneficial to your finances. The Harvard Business Review reports that, “After controlling for wealth, income, skills, and other demographics to level the playing field, the data clearly showed that optimists were significantly more likely to experience better financial health than pessimists, and engage in healthier habits with their money. For instance, we found that 90% of optimists have put money aside for a major purchase, compared to 70% of pessimists. Nearly two thirds of optimists have started an emergency fund, while less than half of pessimists have. Additionally, optimists are more likely to seek out and follow advice from someone they trust. In my opinion, the most compelling finding was how optimists felt, reporting that they stressed about finances 145 fewer days each year as compared to pessimists.”
And, that’s not all. The study concluded that optimists make more money over their careers and are more likely to be promoted.
How to Increase Optimism and Use Pessimism to Your Advantage
No matter how optimistic or pessimistic your thinking is today, you can change. You have control over how you see the world.
Here are a 5 tips for increasing optimism:
1. Be informed
The past – or your individual understanding of the past – influences how you think about the future. And, research suggests that better informed people tend to be more optimistic.
You see, people tend to be unaware of past improvements in the state of the world. And, this lack of information can lead to pessimism and negatively impact financial outcomes.
For example: While it has had dips, the stock market has always recovered and exceeded previous highs. However, many people are fearful of investing in stocks, feeling that they are too volatile. And, others make the huge mistake of selling when the stock market dips because they are fearful of further losses.
2. Practice gratitude
Start or end your day by listing 3 things you are grateful for. This 2-minute exercise rewired elderly pessimists to be more optimistic in just 2 weeks.
3. Visualize the future you want
Imagine a future where your goals are reached is a powerful way to make things come true. Imagining the future helps your brain to see what needs to happen.
4. Focus on progress, not results
Set long term lifelong goals. However, measure your progress in much shorter time increments.
5. Dive in and learn more
Dr. Martin Seligman is considered to be the father of positive psychology. His book, Learned Optimism: How to Change Your Mind and Your Life, draws on more than 20 years of clinical research to demonstrate how optimism enhances the quality of life and how anyone can learn to practice it.