Do optimists make better money decisions?
21 September 2017
Are you an optimist? Do you believe you control your own destiny? How impulsive are you?
The answers to those questions could have as big an impact on your financial future as what you know about things like risk factors and interest rates, according to new research from the Think Forward Initiative.
“I’m very excited about this,” said Nathalie Spencer, behavioural scientist at ING, who helped conduct the research.
“Traditionally, the industry has talked a lot about financial literacy, or what you know. This research is interesting because it asks the question: what kind of person are you?”
Financial capability, simply put, is how good you are with your money. You can find out by asking simple questions about behaviour. Do you struggle to make ends meet on a monthly basis? How resilient are you to financial ‘shocks’? Do you have savings products for the long term or not?
Knowledge is not enough
The research finds that whether you have your finances all figured out doesn’t just depend on how much you know about money (literacy), but also on psychological factors. Like how optimistic or impulsive you are, how you approach challenges, and whether you typically feel that your future is driven by your own actions or by something else outside of your control (known as your ‘locus of control’).
While people who are more financially literate tend to be slightly more financially capable, the results show that this correlation gets twice as strong when these psychological factors are added in.
There was especially a strong and linear relationship between someone’s optimism and their capability — so, the more optimistic someone is, the more financially capable they are, too. This was somewhat of a surprise to the researchers.
Nathalie: “Some optimism is good of course. If you’re depressed it can be hard to make any decisions. But the outcomes suggest that even ‘overly’ optimistic people tend to have higher financial capability.”
“Future research should look more closely at longer-term effects, and one thing we don’t know yet is what causes what — are you financially capable because you’re optimistic, or are you optimistic because you’re financially capable?”
Living on the edge
The research comes at a time when, according to recent ING surveys, three in 10 people across Europe have no savings whatsoever, and 10 percent with personal debt don’t even know how much they owe. Any step towards better understanding financial capability has the potential to help a significant number of people.
The research is a first step. One of the next steps would be investigating cultural differences, as these results come from surveying a representative group of 800 people in the Netherlands.
And then, what can we do with the knowledge that there’s a link between psychology and financial behaviour?
“Policymakers, financial institutions and educators could look beyond teaching only financial concepts,” Nathalie said, “and towards incorporating some of the psychological and emotional aspects of money management.”
“Consumers might benefit from a greater awareness of their own psychological make-up and behaviour. In a world that’s going more cashless, it is especially important to understand how things like impulsivity play a role, because when the act of spending is easier, we have to rely on our own decisions to slow us down. If a bank and a customer know the customer’s profile, they may be able to determine which products or product features are the best match for that particular person.
“I hope this research will help build a bigger picture of what we might be able to do to bridge the gap between financial literacy and financial capability. We know now that a literacy-only focus isn’t necessarily enough to help people manage their finances better.”