In general, do you believe your life will likely get better? Do you think the world will adapt and regenerate or that we’re going on a downhill trajectory? And how do these perspectives shape and influence your choices and daily actions? The positive psychology field, one of the most recent lines of psychology, studied aspects that science has mostly overlooked, and optimism was one of them.
If a few years ago, the studies seemed to point in one consensual direction, by now there are many studies that point out the different takes and traps of optimism, namely how pessimism might, in some situations, prove to be a valid and useful strategy.
Which leads us to ask, when it comes to finances, is optimism our best friend forever or is it a bias that can cost us a lot of money?
What is Optimism Afterall?
Before we discuss the effectiveness and benefits of choosing a hopeful perspective of the future, let's get clear on what optimism is.
One of the scientific definitions of optimism is by Charles Carver and Michael Scheier, that coined the term dispositional optimism to refer to the general tendency to believe that the future is filled with good things and that potential negative events are rare occurrences.
Martin Seligman, one of the pioneers of positive psychology, refers to optimism and pessimism like an explanatory style that makes sense of things when they don’t work out. In the optimistic style, in case of a negative event, a person attributes it to outside causes, that are unstable and specific to that situation. The people who assign internal causes that are stable and recurring to explain negative events, use a pessimistic style.
For example, if someone invests in real estate for the very first time and that property, instead of rising in value, depreciates, that person might assume that this was due to an internal factor, like her intelligence, that there’s nothing she can do about it (stable), and that it will affect all areas of her life (global). In this case, we say she’s using a pessimistic style.
If, on the other hand, in that same circumstance, the person believes that it happened due to a market fluctuation (external factor), that was triggered by an unexpected political decision (unstable ou infrequent) that reflected specifically in the real estate market (specific factor), in that case, we say the person is using an optimistic style.
Of course, these two perspectives have very different implications, the pessimistic style can determine a complete withdrawal from any type of investment, while the optimistic style can cause someone to fail to assess the risks accurately.
Is one invariably better than the other?
Show Me The Studies
Psychologists place the vast majority of the population towards the optimist side of the spectrum. Some studies say that 80% of the population classifies as optimistic, while more conservative studies mention 60% of the population as optimistic.
Studies show correlations between optimism and increased life expectancy, better physical health, better mental health, increased sports and professional performance, greater ability to recover after heart surgery and more adaptive responses to challenges.
In the dispositional optimism studies, Carver and Scheier understood that optimists record less physical symptoms, have healthier habits and more appropriate responses to stress.
Young adult studies show a correlation between optimism and life satisfaction, while pessimism is associated with depression symptoms.
One of the most quoted studies on this topic was conducted by Martin Seligman and involved Metlife’s salesforce, where the results show that the more optimistic salespeople outsell the more pessimistic ones by 56%. Which led Metlife to include in its hiring standards optimism, thus improving retention.
Is Pessimism Really That Bad?
A series of studies imply that pessimism might not be such a bad idea after all. The argument is built around three main ideas: first, that pessimism is a separate construct than optimism, and therefore, the results aren’t always the exact opposite. Second, according to some studies, pessimism might be a better predictor of certain outcomes that optimism. And lastly, that in certain situations pessimism does pay off.
One such study shows that optimistic entrepreneurs make on average less 30% than the pessimistic ones. One possible explanation is that by taking more chances, the optimists also fail more. However, that same study, shows that optimistic employees make more money than the pessimistic ones. There are no studies showing the downside of a positive perspective.
Defensive pessimism is the term used to describe the outlook of people who contemplate the less positive scenarios to prevent unwanted consequences. For example, students who worry about failing a test despite, consistently doing well, can benefit from a sort of immunity in case their worries come to life, or they can use that worry to make sure they’ll do well in the test.
In Finances Does Optimism Help?
A more recent study led by Michelle Gielan in partnership with Frost Bank indicates that when it comes to money, optimists are more likely to act on good financial decisions and eventually reap the benefits of those decisions. Gathering a sample of 2000 people, researchers assessed for optimism, financial health and attitudes towards money, through different scientific scales. Results showed clearly that being an optimist is good for your financial health. Meaning that the positive perspective is associated with healthier financial habits, and therefore, better financial results.
90% of optimists saved money for a significant purchase, versus 70% of the pessimists. Two-thirds of optimists had an emergency fund, while less than half of the pessimists saved up for a rainy day. On top of that, optimists were more likely to ask and follow through on the advice of trusted people. And lastly, optimists spend 145 days less than pessimists worrying about their finances.
It’s hard to talk about investments without reflecting on the example of history’s most successful one to date. Melinda Gates had this to say about Warren Buffet: it wasn’t success that made him an optimist, it was his optimism that made him successful, and even added that optimism is an incredible asset.
Heidi Grant Halvorson, a social psychologist and associate director for the Motivation Science Center of Columbia University, outlines the important distinction between realistic optimists, like Warren Buffet himself, and unrealistic optimists. Realist optimists believe things will get better due to their effort, dedication and ability to overcome challenges, and implement strategies and courses of action to lead them to their goals. The unrealistic optimists believe that success is the universe’s natural reward for a positive outlook.
The scientist Michael Toth studied all the letters Warren Buffett wrote to his stakeholders between 1977 and 2016 and concluded that the famous investor has an extraordinary ability to balance optimism with realism. While the vast majority of letters written were overtly positive, the only 5 letters with a more negative tone were written during the recession in the United States. Showing, that even in times of crisis, instead of ignoring reality, Warren Buffett kept sensitive to it and the context but focused on solutions.
Really dangerous is unrealistic optimism, the belief in easy effortless success, which is hoping that things will magically turn out right.
Optimism in The Stock Market
When it comes to the stock market, there are clear reasons to opt for a realistic optimist perspective. In his book Unshakeable, Tony Robbins collected the 7 facts that help face the fear of a disastrous loss in the stock market:
1. Small market corrections happen on average once a year and can represent up to 20% losses.
2. On average, these movements last about 54 days and represent a 13,5% loss.
3. Less than 20% of those corrections turn into Bear Markets. A Bear Market is the expression used when assets depreciate, and the offer is higher than the demand.
4. Despite these fluctuations and corrections, the stock market registered positive returns 27 out of 36 years, which means 75% of the time the market returns are positive.
5. Despite numerous expert predictions, no one can accurately tell what is going to happen in the markets.
6. The market always rose despite occasional fluctuations and short-term losses. Historically, accentuated and long-term market losses or Bear Markets happen either every 3 to every 5 years.
7. But all Bear Markets turned into a Bull Market (when the market is on the rise, the assets are appreciating and there’s high demand, high hopes, and optimism).
We’re all situated at some point along the optimism spectrum and we can have different outlooks on different areas of our lives.
Just like in the stock market, where 75% of the time things work out for the best, it seems that the belief that, in general, things will be ok and that the attitudes and behaviors we choose matter, especially when facing challenges, is a helpful, intelligent and wise choice, that seems to correspond to reality.
Of course, every once in a while, it might be helpful to contemplate the worst-case scenario to make sure we plan and do everything within reach to meet our goals and pursue our dreams. Above all, the most important thing is that we believe in our ability to face challenges and weather any storm. As long as it takes, as hard as it is, even when the path isn’t clear and the solutions aren’t yet there…. In finance, like in life, believing pays off.