Looking on the bright side may help improve your social life, health and career. Unfortunately, your optimism may also hide risks to your finances.
Too many Americans nurture false hopes in their money decisions -- and the results can be devastating.
But don't worry, it's easy to get protected. Learn how you may be in danger, and how you can avoid potential risks from your optimism.
How your optimism can hurt you:
Neglecting the fine print
Think of the last time you chose to make an investment -- how much time did you spend reading the prospectus? And your last online subscription -- did you read the terms of service? If you're like most people, the answers are: not much and not at all.
According to research, even more experienced investors (like business school students at elite universities, in one study) spend only a few minutes looking at the terms of the funds they purchase. Similarly, only one in a thousand Americans actually reads the license agreement before signing up with an online service.
It's understandable -- contracts are hard to read, filled with legalese and impenetrable jargon.
Unfortunately, skimming documents becomes dangerous as we paint ourselves an all-too-rosy picture of what we're not reading.
As noted by leading legal scholars, Americans are far too optimistic about the unread documents they sign. This overoptimism leads to more firms offering contract terms that are worse for the public, and in some cases, deceiving optimistic individuals.
A decade ago, many homebuyers felt confident that the Adjustable-Rate Mortgage terms they were signing would fit their lifestyle. According to research by noted business economists, these buyers were by and large much less suspicious (and more optimistic) than average Americans. Sadly, many of these optimists didn't find a happy ending with their mortgages - an outcome that helped contribute to the crippling financial crisis of the following years.
Underestimating investment fees
Other areas of overoptimism can be even more dangerous to our nest-eggs. A prime example is our optimism about the impact of investment expenses.
A 2013 survey finds almost 40 percent of Americans estimating their lifetime retirement plan investment expenses at under $10,000, Yet the think tank Demos demonstrates that the actual cost of retirement fund fees for an average household is closer to $155,000. A significant portion of Americans discounts the impact of retirement investment fees by more than 90 percent.
As a result, millions of retirement plan participants have often tolerated unjustified expenses in their retirement portfolios, with fees quietly eating away at their retirement security.
Furthermore, because we're too optimistic about what investment expenses mean, far too many Americans have traditionally accepted advice that seemed free up front, yet may have featured conflicts of interest biased toward overly expensive products.
A just-released Department of Labor study suggests that these conflicts of interest may cost Americans $17 billion a year.
Relying on willpower
Besides being too optimistic about the things we buy, we also put far too much hope in our ability to execute.
We all make New Year's resolutions, with ambitious workout plans and radical cutbacks in tempting, unhealthy food. But the results of our initiatives typically fall well short of early expectations.
Take gym membership as an example. For a fascinating paper, economists tracked gym members' visits over three years. They found that monthly members paid a flat $70, but typically only attended about four times each month -- paying $17 per visit, when they could switch to a flexible $10 per visit option at any time. Those monthly members continued to renew their monthly subscriptions over years, apparently hoping each next month would be different, and giving up around $600 in total savings.
This behavior extends far beyond physical fitness. Americans plan to save for retirement as well, but they are far from saving enough -- targeting savings rates around 12 percent, according to surveys, but typically contributing less than half that.
High expectations of our future willpower can derail us from achieving financial security. Without locking in better habits, our never-ending hopes of saving more tomorrow often lead to procrastination and inaction -- helping contribute to our current multi-trillion-dollar national retirement savings shortfall.
How you can get protected
Luckily, it's not hard to guard against the downsides of a sunny outlook. Like taming any bad habit, the first step is to recognize that you might just have a overoptimism "problem." Then it's important to shield yourself from the temptations of overoptimism, as well as the consequences that overoptimistic choices may bring.
- Set your financial life on autopilot
Overoptimism lurks in all of us. Lock in smart future action to keep it from emerging at the wrong times.
Don't bank on saving more later in your career -- link your investment rate to your income now and fix it to increase regularly in the future.
Set clear-eyed rules for managing your investment portfolio, and automate any future rebalancing accordingly. Don't give your overoptimistic self the chance to be excited by recent trends and seemingly hot new investment opportunities.
- Simplify your options
A complex menu leaves us more likely to take mental shortcuts that can lead to risky overoptimism, or to neglect certain risks hidden in a potential selection.
As a rule of thumb, look first for less complex financial products where possible, and always favor sellers that use simple disclosures, clear print, and plain English instead of legalese in their agreements.
You can also limit unjustified optimism about investment fees using free tools like FINRA's Fund Analyzer for visuals which highlight the bottom line for your choices.
- Support smarter regulations
Required disclosure rules passed over the last few decades have made it much easier for many consumers to compare their options on an apples-to-apples basis, and more clearly see key terms, in everything from mortgages to washing machines. But there can still be significant improvements to the way companies present their services.
By supporting more effective and smarter advertising rules from regulators like the Consumer Finance Protection Bureau, the Department of Labor and the SEC, we can help protect ourselves from the dangers of overoptimism, while encouraging healthy competition in the marketplace.