ATTITUDES: Where's the line between optimism and overconfidence when investing your money? Knowing and practicing the difference could be the key to good financial health.
By ALAN M. WOLF
Raleigh News & Observer
Our outlook on life, it seems, can help determine whether we make wise financial and career decisions. Optimism is good. Cocky can hurt. Using financial and demographic information collected every three years by the Federal Reserve, two finance professors at Duke University concluded that people who are optimistic are more likely to display prudent financial behaviors: saving more money, investing in stocks, paying off credit cards on time, working longer hours.
But overconfident people -- professors Manju Puri and David Robinson label them “extreme optimists” -- tend to have short planning horizons and act in, well, foolish ways: working fewer hours, saving less money, running balances on credit cards. Puri and Robinson examined data from the Fed’s Survey of Consumer Finance to determine participants’ statistical life expectancies.
They compared participants’ statistical and self-reported life expectancies, then categorized anyone who expected to live longer than the data predicted as an optimist. The top 5 percent, those who think they will live an average of 20 years longer than is statistically likely, were labeled “extreme optimists.” The professors then studied the behaviors of people in both groups, as reported to the Fed. Their results were reported in the October issue of the Journal of Financial Economics. The authors say the results could help people understand how personality can lead to bad financial decisions, and help some of us overcome unreasonable confidence.
“Doctors tell us that one or two glasses of red wine a day can be really healthy,” Robinson said. “But no one tells you to drink the whole bottle. It’s the same with optimism. A little bit is really beneficial, but too much can lead to some really bad economic choices.” Put another way: In terms of your portfolio, pocketbook and work performance, pessimism -- from time to time -- might be prudent.
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