Is Your Bank Account Half Empty or Half Full?
When it comes to our ability to make healthy and sound financial choices, mindset matters. If you’re an optimist, you’re likely someone who focuses on growth and advancement. You anticipate the best possible outcomes and — according to some experts — that’s how most of us approach life. “Generally, human beings have optimistic biases,” says Tim Pychyl, associate professor of psychology at Carleton University and author of “Solving the Procrastination Puzzle.” “We wear rose colored glasses a lot of the time.”
Pessimists, on the other hand, concentrate on safety and security and tend to expect the worst possible outcomes. While they may consider themselves pragmatic, the outside world gives pessimists a bad wrap for being too negative and no fun. A Debbie-Downer, if you will.
So which outlook fares best when making big decisions like whether to buy a home, invest or budget? Well, in the end, neither disposition is solely rational or ideal. In fact, a new study by Sophia Chou, an organizational psychology researcher at National Taiwan University, finds that for the best (and happiest) results, you want to embrace a hybrid approach and be a “realistic optimist,” someone who maintains a positive outlook, but also pays close attention to potential downsides.
Let’s put this theory to the test and explore six big money decisions from both sides to see how reaching a happy medium can lead to financial success.
1. Should I Buy a Home?
The Optimist’s Take: Optimists believe in The American Dream, in which home ownership is equated with success — a rite of passage into a world of security, stability and wealth creation. You don't have to worry about rising rent or your landlord kicking you out. But too much optimism about owning real estate, especially its market value, can come back to haunt you. “People have in their mind that prices are [always] going up,” says Victor Ricciardi, finance professor at Goucher College and co-editor of the new book “Investor Behavior: The Psychology of Financial Planning and Investing.” “They just don’t see the end coming.”
The Pessimist’s Take: Pessimists do see the end coming. They zero in on the downsides and risks of owning real estate. And there are plenty: the cost of maintenance and property taxes, losing equity in a down market or falling into foreclosure. And with the most recent housing debacle further framing their reference, it’s safe to say pessimists are far from changing their minds. Can you blame them? “I still believe in real estate, but I completely get the pessimistic take,” says Lauren Lyons Cole, a certified financial planner and contributor to TheStreet.com.
The Happy Medium: When you’re an optimist, you like to keep your eye on the prize, and that fortitude can come in handy, as qualifying for a mortgage takes a lot of financial focus and stamina. But while optimism can help you acquire the means to afford a home, remember the old adage: Just because you can, doesn’t mean you should. It’s something a pessimist might say — and for valid reasons. Pursuing a home just because you think it promises more security or is emblematic of The American Dream is not enough to justify what will probably be the biggest purchase in your entire life. How much will you have left in savings? Will it be enough to pay the mortgage and other necessities for at least six months if you lose your job? What if you decide in a year you want to move to a new state? Are you prepared to sell the house at a loss? What if your property taxes jump by 20 percent next year? The answers to these seemingly pessimistic — though not unrealistic — questions will help you make a more logical decision and better manage potential risks should you decide to buy.
2. Should I Make a Budget?
The Optimist’s Take: Optimists view budgeting as a sure-fire way to tune up your finances. It can lead to a number of positive results like getting out of debt, saving enough for a new place or building a nice nest egg. “It will be my ticket to financial security!” the optimist shouts.
The Pessimist’s Take: Budgeting never works! It’s not possible to stick to strict parameters for every spending category, they think. “The pessimists are probably the same people who have really, truly tried to budget and were not successful,” says Lyons Cole.
The Happy Medium: To convince yourself that budgeting can work, you want to think like an optimist and focus on the benefits. But when it comes to sticking with your budget, you don’t want to be too optimistic in assuming it will be easy to follow. Pessimists are right to think that a budget takes effort. You may struggle for the first few months, but practice does make perfect.
Lyons Cole believes there are ways to set yourself up for budgeting success, even if you have a pessimistic outlook and don’t want to make the effort. Her advice: Begin by carving out all the money you need for necessities like rent, taxes, insurance and other non-negotiables, and budget with only what’s left. “That makes it easier because you’re biting off less to chew,” she says. And focus on small wins, like the fact that you saved a little in a couple of categories. Don't put too much pressure on yourself to execute a perfect budget immediately.
3. Should I Invest?
The Optimist’s Take: Absolutely! What goes up, stays up, is the optimist’s general take on investing for the long run. These folks are not afraid of risk. “They are not going to see the end of a bull market. They’re going to take that optimism and apply it to another year,” says Ricciardi. Additionally, we can be overly optimistic when it comes to imagining our future selves in retirement. We don't think too much about the real needs we may have 30 years from now, which can negatively impact our ability to invest sufficiently for the future. “When we think of our ‘future self’ it’s … the same brain activity as when we think about a stranger,” says Pychyl. “It’s part of a coping mechanism to feel good now.”
The Pessimist’s Take: Pure pessimists don’t entertain risk. There’s an assumption that money managers are not to be trusted and that your money is best kept under the mattress. As with real estate, present-day pessimists don't trust that investing in the market will pay off, especially after watching the market crash during the Great Recession (even though it’s recovered since). “The general public is still anchored on that point,” says Ricciardi. “It’s still having a detrimental effect and keeping a percentage of people in a pessimistic mood.”
The Happy Medium: One ideal characteristic for investing is what Pychyl calls the “Defensive Pessimist,” someone who thinks she is going to fail or lose money but then turns that pessimism into fuel for pursuing the best possible outcome (as an optimist would). “If you’re a pessimist who’s motivated to avoid failure, that can be very successful,” says Pychyl. In other words, if you really think that there’s no way to make money in the markets over the long run, think about your other options to ensure that you, in fact, have a comfortable retirement. Sitting on your hands? Counting on the measly interest rate you’re earning in a standard savings account? You may begin to realize that the stock market has its advantages, which it clearly does.
Additionally, if you’re overly optimistic about the market, Ricciardi suggests playing the devil’s advocate to create better results. “Have a part of your portfolio that is contrarian, and automatically rebalance yearly to ensure that when the market is going up, you control your optimism with a strategy that takes some money off the table and puts into a safer asset,” he says. Vice versa for pessimists. Have a small part of your overall portfolio in riskier investments that may do well when all else is falling. “Force yourself to create that happy medium between being an optimist and pessimist,” says Ricciardi.
4. Is It Worth Asking for a Raise?
The Optimist’s Take: “Optimists would expect that if they asks for a raise, they would definitely get it,” says Lyons Cole. “They’d be less afraid, and that’s the type of optimism that can really make a huge difference in your financial life.”
The Pessimist’s Take: On the other hand, “Pessimists would think of all the reasons their boss would say no,” she says. Their outlook would prevent them from ever asking, and years later their salaries may lag behind their industry peers.
The Happy Medium: While optimism is certainly needed — and encouraged — to get you motivated to request more money, don’t let that optimism turn into negligence or an assumption that a raise is a guarantee. There’s still the chance that your boss will turn you down, and you should be prepared for that. Like a pessimist, think of all the reasons your manager may say no and come to the meeting ready and armed with highlights of your accomplishments and why you think you’re worth it.
5. Should I Switch Jobs?
The Optimist’s Take: It’s not unusual for an optimist to sit at her desk and daydream of a brighter, more exciting 9 to 5 at a different company or in a completely different career. In her mind, there’s only upside potential to quitting and working someplace else. The grass will be greener, she thinks, and frankly anyone would love to hire her. With that optimism comes, in theory, the confidence and motivation to make change happen.
The Pessimist’s Take: There are a lot of unknowns when switching jobs, and that would be a pessimist’s primary reason for staying put. Who knows if you’ll like your new co-workers? What if the new company gets bought out or dissolves? What if you end up not liking the position, after all? Plus, starting fresh at a new company is so much work.
The Happy Medium: Optimism can better lead you to getting hired. In fact a study produced by researchers at Yale School of Management and Duke University's Fuqua School of Business discovered that job seekers who took on an optimistic viewpoint were more likely to prevail in the competitive hiring market and score a new position quickly. But it’s important to temper that optimism with some pessimism and consider the cons of moving to a new company. While optimists might focus on favorable outcomes like a better title and higher pay, pessimists are right in considering the trade-offs, as well. For example, if the commute is twice as long, how might this new job impact your work-life balance? Or, let’s say at your current company you have a lot of seniority. As the new gal, might you lose some perks? Oh, and as it turns out, the health benefits aren’t as generous. How will this eat into your budget? Be optimistic, but consider any sacrifices to steer yourself towards a smarter decision. The grass might actually be greener where you stand.
6. Should I Start a Business?
The Optimist’s Take: There’s no better way to work than to be your own boss, thinks the optimist. Even if I have to cash out my 401(k) and deplete my savings account, it’s worth the risk because this business will succeed, she says. I won’t have any regrets because I’ll be following my dreams! What could be better? “But the downfall to focusing purely on the positive is that you lose sight of reality and fail to have realistic expectations and goals,” Lyons Cole explains. “You could end up in a position where you suddenly have no choice because of a lack of awareness.” And that last thing you want is to be stuck in a situation where you have no money to your name.
The Pessimist’s Take: As pessimists are generally risk-averse — and starting a business is one of the riskiest ventures in life — they’re not exactly excited by the idea. Rather than focus on the upsides of starting a business, pessimists worry about the upfront costs, the risks of quitting a day job and the likelihood of failure and having nowhere to turn.
The Happy Medium: The successful entrepreneur blends the best attributes of optimism and pessimism. She is passionate, determined and confident that the future will be brighter. At the same time, she is levelheaded and anticipates risks and plans accordingly because then you are less likely to be caught off guard or to be ill-prepared for headwinds that will most certainly arise. One common optimist pitfall, for example, is to assume that starting a business with a close confidante would be the ideal situation, but as Harvard Business School professor Noam Wasserman and author of “The Founder’s Dilemmas” told The New York Times, starting a business with friends or family “is the least stable. It’s the most likely to end up in disaster.” Think critically about each step and have a Plan B ready if and when things don’t go in your favor. In the end, you want to do as Steve Jobs would do, says Wasserman. “Follow your heart, but check it with your head.”
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