Extreme optimists tend to splurge, study says

By Jeanna Bryner

updated 2:58 p.m. ET Nov. 13, 2007

Optimism, it turns out, is best in moderation.

People who have a rosy outlook are more likely than others to make prudent financial decisions, but those who are extreme optimists make riskier investments and save less money than others, a new study finds.

Manju Puri and David Robinson, professors of finance at Duke University in Durham, N.C., compared statistical and self-reported life expectancies to determine people's levels of optimism.

Overall, they relied on data on families in the United States, collected in 1995, 1998 and 2001 as part of the Federal Reserve Board’s Survey of Consumer Finances, which included self-reported life expectancies, health factors and demographics. The SCF typically surveys about 4,500 Americans every three years.

The researchers compared the self-reported life expectancies with statistical ones, grouping participants who expected to live longer than the data predicted as "optimists." Participants who expected to live an average of 20 years longer than is statistically likely were labeled "extreme optimists."

In moderation, optimism can lead to sensible decision making, but extreme optimists “display financial habits and behavior that are generally not considered prudent,” the authors write in the October issue of the Journal of Financial Economics.

The results held across demographic, risk-taking dispositions and health-related issues. They find that compared with others, optimists:

• Work longer hours
• Invest in individual stocks
• Save more money
• Are more likely to pay their credit card balances on time
• Believe their income will grow over the next five years
• Plan to retire later, or not at all
• Are more likely to remarry if divorced

In comparison, extreme optimists:

• Work significantly fewer hours
• Hold a higher proportion of individual stocks in their portfolios
• Are more likely to be day traders
• Save less money
• Are less likely to pay off their credit card balances on a regular basis
• Are more likely to smoke

“The differences between optimists and extreme optimists are remarkable and suggest that over-optimism, like overconfidence, may in fact lead to behaviors that are unwise,” Puri said.

The researchers liken optimism to red wine.

“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.”

Further research is needed to tease out reasons why moderate and extreme optimists behave differently, the authors say.

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