Charlie Munger, the legendary investor once described himself as a rational optimist. For a man who was brought up during the great depression of 1930s America, and who lost a young son to cancer, this is a remarkably uplifting attitude. 

As a financial advisor you need to be an optimist. If you’re not – you’re in the wrong job! This is because successful financial planning and long-term investing require significant faith in the future. Faith in humanity to continue progressing, trust in the financial system to continue operating with integrity, and confidence that short-term market crises will be temporary.

History, as we know it, provides a solid case to consider this optimism rational, and we believe this attitude is a significant indicator of an investor’s future success. Wherever possible, we encourage more of it in our clients as we know that it results in a focus on the long term and better investor behaviour.

While we will continue to espouse the benefits of rational optimism, it must remain within the bounds of rationality. Left unchecked, the investor is entering dangerous territory.

The Downside of Unrestrained Optimism
While rational optimism is critical to long-term success, blind optimism can lead to poor decision-making.

Successful investing requires the ability to hold two opposing thoughts at once. We observe from history that the world keeps getting better for most people, most of the time. However, we also know that terrible events and misfortune still befall some people, some of the time.

Naive optimism, often characterised by an attitude of “it will all work out”, can lead to an ignorance of possible risks. We see this in the attitude of some investors, and it can undo otherwise perfect financial plans.

A Balancing Act
While we will never advocate for pessimism, we believe a certain amount of prudence is required when developing a financial plan. This prudence can show up in different ways, but we want to explore three common examples.

Conservative Assumptions
The first is the desire to always use conservative assumptions when making financial projections. This simple act creates a margin of safety, allowing the plan to work out even if future returns are lower than past returns. This trade off comes at a cost. Conservative assumptions will require larger investment contributions and more sacrifice of spending by the investor. Mature investors accept this as a sensible strategy.

Assess Possible Risks
Another result of prudence is the acceptance of unlikely but high-impact risks. Life and disability insurance, an exchange of risk that comes at a cost, is too often waved away as unnecessary. The mature investor decides to prepare for all scenarios even though they know many will not occur.

Create a Safety Net
Lastly, for many investors, prudence shows up as a willingness to allocate a portion of their capital to a safe but ultimately suboptimal cash investment. They do this to weather the inevitable temporary market declines with discipline without the need to redeem perfect long-term investments at an inopportune time.

A Second Set of Eyes
Ultimately, prudence allows us to correctly consider the range of possible outcomes, providing peace of mind that our chosen actions will result in success no matter what the future holds.

While we advocate for prudence during the planning stage, we encourage investors to set it aside for rational optimism as soon as they start implementing the plan and walking the journey to financial independence.

Our role is to facilitate the conversations that will identify the risks you and your family face, helping you evaluate their impact and the best way to mitigate them. We also provide an experienced second set of eyes trained to identify your blind spots.

Most importantly, we aim to provide the long-term support and encouragement you need to remain optimistic about your future. We are confident that a prudent plan, an attitude of optimism, and the help of an adviser will guide you to a secure and independent retirement.