Optimism has become a cult these days. Both mainstream and social media outlets strongly encourage their readers, viewers, and listeners to keep believing that everything will be fine no matter what. This largely happens because optimism is easy to “sell”. It gives you hope in almost all situations even when objective and unbiased analysis and data often show that there is no hope whatsoever. So what?
The thing is that a recent major study demonstrates that optimism is actually dangerous for your financial well-being (“Looking on the (B)right Side of Life: Cognitive Ability and Miscalibrated Financial Expectations”, Chris Dowson, School of Management, University of Bath, Sage Journals, 10 November 2023.)
The study’s author Dr. Dowson concludes that “…Unrealistically optimistic financial expectations can lead to excessive levels of consumption and debt, as well as insufficient savings. It can also lead to excessive business entries and subsequent failures. The chances of starting a successful business are tiny, but optimists always think they have a shot and will start businesses destined to fail.”
Practically speaking, “the research found that those highest on cognitive ability experienced a 22% increase in the probability of “realism” and a 35 per cent decrease in the probability of “extreme optimism” (see Picture 1 below).
Yet another research shows that 2/3 of retail investors make investment decisions impulsively, being in an emotionally unstable state. Furthermore, every third retail investor buys or sells shares while being under the influence of alcohol. Among the members of Generation Z this percentage reaches 85% and 59%, respectively (see Picture 2 below).
This is explained by the fact that between rational analysis and hope humans intuitively choose hope. For example, according to the results of a YouGov survey conducted in 2021, 6% of Americans believed they could beat a grizzly bear in a fist fight while being unarmed (see Picture 3 below). 8% would beat a lion or an elephant, 12% a wolf, while 23% would beat a big dog.
Personally, I think the right picture (see Picture 4 below) is much closer to reality than the left “optimistic” one. (P.S. Blockbuster plots were not included in the survey).
Imagine the results if drunk people had been selected to take part in this survey. Most likely, it would have looked like this: “To beat a lion is too simple. An elephant. I will certainly overpower it. A grizzly bear. Most likely, I can handle it too. A Tyrannosaurus Rex. Now that’s interesting! I should try it!” The result of making a decision in this state is obvious. Especially in the context of financial markets. However, it will be too late because financial markets do not forgive strategic mistakes. And, most often, they do not allow you to restart the “game” again.
Does it mean that you have to be a pessimist if you want to be a successful investor? I do not think so.
First, pessimism is bad for your health. And the best investor is a healthy investor.
Second, we need to figure out how pessimism differs from optimism and realism (see Picture 5 below).
If you are an optimist, you are likely to do something you should NOT do.
If you are a pessimist, you are likely NOT to do something you should do.
If you are a realist, you are likely to do something you should do.
In general, being a realist may seem a bit boring. But it is definitely good for your financial well-being. As Benjamin Graham put it: “The intelligent investor is a realist who sells to optimists and buys from pessimists.”
I would add that sometimes when somebody tells you: “You’re strong, you can handle this job/project/investment/etc.”, you should politely say: “I’m smart enough, I won’t even take it.”
