A little optimism leads to healthy financial decisions, according to researchers. Too much leads to overconfidence — and unpaid bills.
Finance professors Manju Puri and David T. Robinson’s paper “Optimism and Economic Choice” is the first of its kind to link optimism to major economic choices. The professors developed a numerical formula for optimism using data from the Survey of Consumer Finance, which looks at the economic health of the U.S. economy based on individuals’ employment status, portfolio holdings, life expectancy, attitudes toward risk and more. Puri and Robinson calculated optimism by measuring the difference between a participant’s self-reported and statistical life expectancies, based on smoking, age, gender, race and education. You are considered an optimist if you expect to live longer than the data predict you will.
It will get better
Findings from the study reveal that optimists are more inclined to believe that future economic conditions will improve. Optimistic people work harder, expect longer age-adjusted work careers and are more likely to remarry after divorce. Optimists think they will retire late if ever and are more likely to invest their portfolios in individual stocks. The fact that optimists own a larger portion of their equity wealth in individual stocks “suggests that our measure of optimism captures the idea that optimists place greater weight on more positive outcomes than pessimists do,” the professors say.
The study also found that self-employed workers are more optimistic than regular 9-to-5ers. Optimistic people are generally more responsible with finances. They view work more favorably and work longer hours than others. They are more likely to save money.
Optimists and credit cards
Optimism also relates to credit card use. “Manju and I found that optimists are more likely to pay off their credit card balances at the end of each month, but that this effect only holds for moderate optimists,” Robinson says. “There is a positive association with being optimistic and paying your credit cards in full.”
If you are an “extreme optimist,” as Puri and Robinson call it, you are less likely to be careful with your finances. Extreme optimists are the top 5 percent of optimists, and believe they will live an average of 20 years longer than is statistically probable.
Extreme optimists work less, save less and usually carry balances on their credit cards. They see things more in short-term than in long term. They are also more likely to smoke cigarettes. “The differences between optimists and extreme optimists are remarkable, and suggest that over-optimism, like overconfidence, may in fact lead to behaviors that are unwise,” Puri says.
Robinson adds that extreme optimists actually act similar to pessimists.
Robinson compares optimism to red wine — a little each day is great for you, but too much will result in poor decisions. “Being optimistic in the right measure is healthy, both for your economic and financial decision-making,” Robinson says. “But don’t carry it too far.”
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