Editors' pick: Originally published Jan. 13.
Call it a matter of mind over money. Yes, a new study demonstrates that believing in yourself, believing in your ability to succeed, improves the odds of avoiding financial distress.
"Individuals who believe more strongly that they can change future outcomes though their actions, are less likely, years later, to be delinquent on loans, and to suffer consequences such as having assets repossessed or property foreclosed, or to lose access to traditional credit," wrote the authors of report recently published by the National Bureau of Economic Research.
What's more, the researchers, Camelia Kuhnen, an associate professor at the University of North Carolina's Kenan-Flagler Business School, and Brian Melzer, an assistant professor at Northwestern University's Kellogg School of Management, discovered that "those with higher self-efficacy prepare more to avoid financial distress later in life, and have a lower probability of being financially delinquent upon facing negative financial shocks induced by a job loss or a health event."
In their study, Kuhnen and Melzer investigated what they described as "a novel determinant of household financial delinquency, namely, people's subjective expectations regarding the cost-benefit trade-off in default decisions."
These expectations, wrote Kuhnen and Melzer, are determined by individuals' self-efficacy, which is a non-cognitive ability that measures how strongly people believe that their effort will influence future outcomes.
"Complementing prior findings regarding the effects of cognitive abilities, financial literacy and education on economic behavior, our evidence suggests that non-cognitive abilities have an important role in household financial decision making," wrote Kuhnen and Melzer.
Or put another way, non-cognitive skills play an important role in determining financial success.
The authors further noted that in their conclusion that "identifying the role of non-cognitive abilities such as self-efficacy on household financial outcomes is useful, because, unlike other characteristics that may be pre-determined, non-cognitive skills can be improved via interventions at various stages in life."
Referencing another study, the authors noted that "it's possible that by helping people believe more in their own capacity to influence the future, they will in fact take action and achieve better financial outcomes."
Application to retirement?
And that conclusion got us thinking. What's the takeaway for those saving for retirement? Should they, for instance, take self-help classes that help believe more strongly that they can change future outcomes - the odds of achieving the retirement they desire -- through their actions? Should folks take self-assessment tests, for instance, to determine their level of self-efficacy? And what sort of interventions should people seek out?
And the answers, at least according to a co-author of the study is yes and now.
"Self-efficacy is one of the non-cognitive skills that make up a person's character," said Kuhnen. "Cultivating good character is probably not something that can be achieved through a single self-help class or a simple intervention."
In fact, building such a skill, she wrote, takes time, the right group of peers, the right social environment.
"But I would say that people of all ages who are aware that they may face financial stress later on should have a mindset of asking, 'How can I avoid this potential trouble?' rather than saying, 'I'll be in financial trouble,'" she said.
In other words, don't simply accept a bad outcome before it happens. "Ask yourself what you can do to prepare to avoid it," said Kuhnen. "In the case of retirement, long before that happens people need to have a plan for how they're saving, every month, so they can retire comfortably. Kicking the can down the road and postponing thinking about how to save for retirement will guarantee a bad outcome."
What should those saving for retirement do then? They should make it a routine to check on their financial health -- say, to see if their retirement savings are growing as planned -- on a regular basis, a few times per year, said Kuhnen. "A difficult financial situation is not something to be avoided, but rather, it has to be confronted early on, before things spiral out of control," she said. "Unfortunately, many people are not comfortable with financial terms, and because of that they end up in tough situations, without a clue as to how to fix the problem."
Lack of financial literacy a problem
And this, said Kuhnen, is not about self-efficacy or character -- but rather, it is a lack of financial literacy. Now, this aspect -- financial literacy -- can certainly be taught in a class, to people of all ages. "So, if there is one intervention that I would recommend, it is to have basic financial literacy classes taught in school early in life, and, also, to have such classes available to those who are past their high school or college years," she said.
To be fair, not all academics share this point of view. "There is by now good evidence that the role of financial literacy in financial adequacy, such as adequate retirement savings, is much exaggerated and the roles that matter are non-cognitive roles such as personality -- conscientiousness and self-control -- and habits," said Meir Statman, a professor at Santa Clara University's Leavey School of Business and author of a forthcoming book called Finance for Normal People, which addresses this very topic. "Indeed, men excel at financial literacy, but they are lousy at financial comprehension and financial behavior."
If you believe it, it will happen
But academics do seem to agree that positive thinking can play a role in achieving the retirement you desire. "I'm a firm believer in the power of positive psychology," said Benjamin Cummings, an associate professor of behavioral finance at The American College of Financial Services.
For instance, the early days of sports psychology research showed that people's thoughts can have substantial impacts on outcomes, Cummings noted.
"It's not surprising that people who think their actions make a difference actually fare better financially," he said. "It's the opposite of what might be called the 'Eeyore effect,' from Winnie-the-Pooh, who just accepted the bad things that happened to him rather than trying to prevent them. Instead, if you have a positive outlook and think you can make a difference, guess what? You probably can."
Cummings also noted Kuhnen and Melzer's references in their paper to the psychological construct of locus of control -- the extent you feel in control of the events that influence your life. "Individuals with an internal locus of control probably have higher self-efficacy," he said.
Can self-efficacy or locus of control be change?
As for whether one's self-efficacy or locus of control be changed by encouragement by others, Cummings said the answer is yes, but there's a caveat.
"I personally believe that humans have an inherent ability to change, but I think we need to further investigate how to enact effective change, and how any internal changes to character might impact financial outcomes," he said. "I think there's a lot of merit in considering the impact of character traits beyond cognitive ability. Intuitively, it makes sense that more emotionally stable individuals have better financial outcomes, and it's exciting to see that these concepts are being incorporated into financial research."