Are you an optimist or a pessimist when it comes to money? Why does financial optimism work better than financial pessimism?
In his book The Psychology of Money, Morgan Housel says that you should remain optimistic when it comes to finances and investing, no matter what others say. He outlines three reasons why financial pessimism often seems like the smartest route but isn’t.
Keep reading to learn why an optimistic view on finances and investments is beneficial.
Don’t Be Put Off by Pessimism
Just as you shouldn’t be put off by uncertainty, Housel suggests, don’t be put off by pessimism.
Housel explains that we’re likely to believe financial pessimists because they tend to sound smarter and more reasonable than financial optimists. However, Housel contends, this is a mistake: Given our world’s history of long-term growth, the optimistic view is generally more reasonable than the pessimistic. Therefore, he argues, you must be able to evaluate financial pessimism appropriately so you don’t overreact when you encounter it.
To react appropriately to financial pessimism, Housel argues, you must understand why it’s so tempting. Housel explains that, while pessimism is alluring partly due to our instinct to prioritize threats over opportunities, financial pessimism, in particular, seems especially reasonable for three main reasons.
(Shortform note: In the blog post he based his book on, Housel presents a number of reasons that financial pessimism is smarter than financial optimism that he doesn’t include in this book. Notably, he discusses how people are skeptical of optimistic viewpoints partly because the finance industry is full of hacks who’ll scam you with stories that are “too good to be true”—a danger you’ll learn more about in Lesson #18. So while you shouldn’t overreact when you encounter pessimism, it may be unwise to discount it entirely, too.)
#1: We pay more attention to bad financial news because we’re afraid that it might affect us, too.
Housel explains that since our modern financial systems and economy are so interconnected, a negative event in one sector is likely to affect someone in another sector—even if those sectors aren’t related. For example, the housing market crash of 2008 didn’t just affect real estate investors; it prompted a nationwide recession that affected everyone, including people who hadn’t invested in real estate.
(Shortform note: In the blog post he based this book on, Housel shares another reason we pay attention to financial news: Money has competitions, rules, and upsets—like a game—so it’s entertaining. There, he also argues that we pay attention to financial news because others’ actions may affect our own finances. But, instead of arguing that we fear this, Housel argues that we enjoy this because, when you’re emotionally invested in the outcome, watching the game of money becomes more entertaining.)
#2. It’s easier to make a pessimistic forecast than an optimistic one.
Housel argues that many people forecast pessimistic outcomes by assuming that the current trend will continue and ignoring how the market might adapt to the world’s needs. However, Housel explains, extreme trends normally don’t continue because the markets adapt to extreme circumstances. For example, Housel cites a 2008 prediction that the world would run out of oil because China would need 98 million barrels a day by 2030 but we couldn’t produce more than 85 million. This prediction didn’t come true because the market adapted: China’s increasing demand for oil raised oil prices, which incentivized people to develop better drilling technologies and to drill in places that were previously economically unviable.
(Shortform note: Instead of forecasting the future by extending current trends, management consultant David Mattin recommends focusing on what doesn’t change—and the fact that humans inevitably adapt to extreme circumstances may be an example of that. For example, humans faced the consequences of oil overuse on the climate and adapted by electrifying vehicles. Experts now expect Chinese oil consumption in 2030 to be lower than their 2008 predictions because they’ll use more electricity and less oil in their transportation.)
Because predicting how the market might change is difficult, economic forecasters often take the easy route and ignore it. (Shortform note: In other words, the economic forecasters fall victim to a mistake we learned about in Lesson 3: They don’t consider that unpredictable events might surprise them.)
Furthermore, it’s easy to believe these forecasts because they don’t require you to imagine an entirely new world: They work in a world that’s familiar to you. (Shortform note: We may also believe these forecasts simply because we like them more: The mere-exposure effect is a psychological phenomenon where people like something more merely because they’re familiar with it.)
#3: It’s easier to notice negative events because they happen more suddenly.
Housel explains that progress compounds slowly—over months and years, if not decades. So noticing this progress requires a lot of work: You have to pay attention to small, incremental growth over a long period of time and you have to clearly remember the state of a situation in the distant past, both of which are hard to do. As such, most of us are slow to notice progress if we notice it at all. Conversely, Housel argues, destruction occurs quickly, often with just one dramatic event. As such, it captures our attention in a way that progress doesn’t.
(Shortform note: How can you make noticing progress easier? Consider noticing and celebrating small wins on issues you care about—no matter how small. In The Power of Moments, Chip and Dan Heath explain that noticing and celebrating small wins makes the long-term goal feel more attainable. While the Heaths recommend celebrating your wins to achieve your own long-term goals, the idea is presumably applicable to goals you’re invested in but not necessarily involved in, like a political issue you care about.)
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Here's what you'll find in our full The Psychology of Money summary :
- Why the key to financial success lies in understanding human behavior
- How to make better financial decisions
- How chance plays a bigger role in our financial lives than we think