Friday, August 20, 2010

5 Money Rules for Pessimists

When it comes to personal finances, pessimism gets a bad rap. “The one exception where pessimists might have a leg up over optimists is money management,” says Colorado Springs, Colorado financial planner and CBS MoneyWatch blogger Allan Roth. “They worry more, so they tend to save more.”

Pessimists are also more cautious. In studies that looked at optimists, pessimists, and gambling tendencies (a good parallel to the stock market), researchers found that pessimists tend to bet less and expect less when the gaming isn’t going their way, so they lose less. That’s right, pessimists, fret not (if you can help it): Seeing the glass half-empty might net you a fuller glass at the end of the day. That’s because pessimists have some characteristics on their side, such as caution, that can translate into more stable financial portfolios and larger retirement nest eggs. If you’re a pessimist by nature, the key is to harness your realism — while tempering the negativity. Sure, it’s good to keep in mind that black swans occur and stock markets can crash, but it’s counterproductive to assume that no risky investments will ever pay off. Here are five rules to help:
1. Get Control of Your Fear

There’s a basic principle called loss aversion that influences our financial decisions: the high you get from winning isn’t as powerful as the low you feel from losing. This phenomenon is exacerbated for pessimists. “When losses happen, pessimists are miserable, and when gains happen, they’re not as happy as they think they will be,” says Dan Ariely, a professor of psychology and behavioral economics at Duke University and author of The Upside of Irrationality. Pessimists should try to view risk as the cost of doing business, and remind themselves that it makes sense to take some risk. For example, consider all the probabilities when investing for retirement: The odds of the stock market going nowhere for 30 years are fairly low, while the odds of money markets lagging inflation over the next 30 years are fairly high.

2. Give Yourself Permission to Spend

“I have to tell my pessimist clients: You have permission to spend some of your money,” Roth says. “Even the ones with huge nest eggs are afraid they’ll wind up with nothing somehow.” There is a big difference between frugal living and withholding your spending to the point that your quality of life suffers. The huge nest egg when you’re 80 won’t wipe out the regret you feel for not taking those vacations you could have well afforded when you were 50. Set aside a cache of spending money — in a separate account even. Ignore that savings when it comes to calculating your future needs; that should help you get comfortable with the idea that you’ll be spending it.

3. Partner Up

“Having a financial companion to talk things over with can be really helpful,” says Moshe Milevsky, a finance professor at York University. Ideally, it’s someone who neither echoes your pessimism nor counters everything with optimism. Pessimists can really benefit from a neutral sounding board, whether it’s a spouse, friend, or financial planner.

4. Assess Your Insurance

“Pessimists tend to be over-insured, especially for life insurance,” Milevsky says. Those premiums can be wasted money if the value of your policy is out of line with your financial responsibilities. “Do a rational, analytic assessment of your insurance and what you’re spending in premiums,” he says. The point of life insurance is to provide your dependents with a replacement income stream if you should die. So buy enough insurance to cover their needs, nothing more.

The same is true for extended warranties, which tend to be expensive. They’re worth it sometimes — but not all of the time, especially since the chances of multiple items breaking at once is low. Channel your realism (not your negativity) to weigh the probabilities, and then self-insure by diverting the money you would otherwise have spent on warranties into a savings account instead.

5. Stop Watching Your Portfolio

“If you tend to only see the negative, don’t look too frequently at your investments because you will only be miserable,” Ariely says. Even more important, don’t be reactive. It goes back to loss aversion: Be careful of doing something spur of the moment (like pulling all of your money out of the stock market) because you want to avoid the misery you fear is coming. “It’s good to evaluate, but don’t evaluate based on emotion,” he says, especially if you’re in a doom and gloom mood. Instead, take the long view. If the market has just crashed, for example, ask yourself: a year or two after a market crash, is it usually higher or lower?

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