Learn How Optimism Can Hurt Your Finances

Apr 1, 2016
Author: Scott Hanson

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Can you predict the future?

Maybe pessimists can.

One of the things that has most fascinated me over my 25 years as an advisor is the number of people I’ve met with who insist that they can “time” the markets. These folks are certain that their research (or intuition) places them in the position of knowing precisely when to jump in to the markets and invest the farm, and when it’s time to pull back and play it safe.

Yet I know, in spite of being a student of finance and working with some very smart people—people with 30 or more years of investment experience—that we can’t consistently predict market outcomes.

By “we,” I mean that nobody truly knows where the markets are going to go from day to day.

But there are lots of confident people—folks I meet on the street, clients who come into our offices, or people who call into our weekly radio program, Hanson McClain’s Money Matters—who remain unshakable in their belief that they can predict where the markets are headed.

 

Market Gyrations - What you need to know

Optimism Breeds Happiness and Health

Confidence can be a good thing. That’s because a trend toward confidence is usually rooted in a mostly-terrific personality trait: optimism.

According to Daniel Kahneman, the 2002 winner of the Nobel Prize in Economics, and the author of more than 20 books, including 2013’s Thinking Fast and Slow, “Optimists are normally cheerful and happy, and therefore popular; they are resilient in adapting to failures and hardships, their chances of clinical depression are reduced, their immune system is stronger, they take better care of their health, they feel healthier than others and are in fact likely to live longer.” 

The Optimist’s Flaw in Market Timing

But when it comes to finance, optimists can be blind to their own shortcomings, and therein resides the downside.

According to Kahneman, when it comes to investing, optimists tend to believe that defeat is just a temporary setback, and that its causes are confined to just that one particular case or scenario. Simply, many optimists don’t believe that defeat is their fault. They see it as a fluke. Or that circumstances, bad luck, or other people brought it about.

Some optimists are unfazed by defeat, and instead of changing their behavior, believe they only need to try harder to succeed. This leads them to repeat the same investment mistakes over and over.

Said Kahneman: “Apart from ethics, the other main culprit for the economic downturn (of 2008) was investor optimism.” Kahneman has called optimism the “engine of capitalism.” But goes on to say that: “Because optimists are more likely to ignore history, they do things (such as invest over confidently) that they have no business doing because they believe they’ll eventually be successful.”

In this scenario, overconfidence and optimism, which can lead to aggressive risk taking, all in the hope of realizing that one big score, can in fact negate years or even decades of steady growth that has been realized by an otherwise careful, long-view approach to investing and retirement preparation.

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