I don't typically turn to stock reports for self-help inspiration. But there's a market quirk that shows up each New Year that's gotten me thinking about the "economics" of our own New Years resolutions.
For the first two weeks of each new year, small stocks outperform the overall market in the U.S. What’s behind this so-called “January Effect”? The typical explanation goes like this: In December, investors dump losses to get a tax break, which pushes prices down. Low prices entice January buyers, which drives stocks back up.
But lately, economists have been floating a new theory. The January Effect is the result of good old-fashioned New Year’s optimism. That’s right, the same hope that has launched a million diets is behind one of the most robust market trends in history. At the very same time resolutions are being set, unrealistic market optimism peaks. We’re all optimists in January.
The January Effect is just one example of the human mind’s desire to imagine a positive future. And while optimism helps us tackle challenges, new research from both economics and psychology reveals how much a liability unrealistic optimism can be. For example, a recent analysis found that 75% of cases investigated for fraud by the SEC are the result of unrealistically high initial profit projections. When reality doesn’t match the predictions, companies “manage earnings,” hoping profits will catch up. And while they’re busy ignoring reality, they’re missing opportunities to fix what’s going wrong.
Optimistic New Year’s resolvers show a similar tendency to cook the numbers. Most people make wildly unrealistic predictions about how much they will exercise. But when confronted with the gap between their predictions and their actual exercise time, people don’t become more realistic. Instead, they increase their estimates when asked to predict how much they will exercise in the next month. Like companies trying to catch up to projected earnings, would-be exercisers ignore reality and aim even higher. In the meantime, they aren’t doing any of the analysis needed to figure out why they didn’t exercise, and what they need to do to make sure it happens.
In both cases, the goal is to maintain expectations, not to correct course. This is how optimism gets us into trouble. Economists call this “delusional optimism.” We refuse to adjust our expectations. Economists even have a word for those deluded by optimism: “lemmings.” Lemmings are blind to the obstacles in their path, and just keep pushing on to their inevitable demise. In the face of setbacks, they become more optimistic, right up to the point where they fall of the cliff. The money runs out, the investors walk, the SEC steps in—and everyone is forced to confront the fact that things aren’t going as hoped.
For many, setting a New Year’s resolution is an exercise in going over the cliff. Psychologists have found that the stronger a person’s optimism, the more they underestimate the challenges they will face, and the less likely they are to ask for help. They’re also more shocked by setbacks, and more likely to give up on their goals. That’s why smokers who are most optimistic about their ability to quit tend to fail first, and dieters who are most optimistic about weight loss are the least likely to succeed. They are the lemmings. They’re hopeful right up until the moment they abandon their resolution.
There is another way to deal with the inevitable setbacks that every New Year’s resolution faces. While lemmings focus on the feeling of hope, “trackers” focus on obtaining the best possible outcome. They notice the gap between ideal and real, and they adjust their expectations. They acknowledge setbacks and look for ways to get back on track.
So how do you get to be a tracker, not a lemming? In the business world, smart companies assign someone the role of professional pessimist. How might things go wrong? What are the biggest risks? Psychology research shows there is a simple way to get the same strategic benefits of pessimism for your New Year’s resolution. First, identify your goal, and imagine the best possible outcome of following through. After all, we need a burst of hope to find our motivation. So if your goal is to exercise three times a week, you might imagine your high school sweetheart swooning at your twentieth reunion. Or picture your doctor astonished by your weight loss and announcing it’s time to get off the blood pressure medication.
But then get your mind out of its optimistic fantasies. Ask yourself: What is the biggest obstacle to this goal? Get specific. When and where is this obstacle most likely to occur? What can I do to prevent the obstacle from occurring? Now start thinking like a tracker, not a lemming. Ask yourself: What specific thing will I do to get back on track when a setback happens? In one study, would-be exercisers who did this thought experiment everyday ended up exercising twice as much as those who simply set the goal to get fit. The effect lasted all the way through a four-month follow-up -- call it an “April Effect.”
Whether you’re launching a start-up, a new budget, or a diet this January, enjoy the optimism that bubbles up with the traditional New Year’s champagne toast. But when the party’s over, enlist your inner doubter to get to work. Your bottom line and your waistline will thank you next December.
For more on the January Effect, see Investor Optimism, False Hopes and the January Effect (Ciccone 2011 Journal of Behavioral Finance).
Kelly McGonigal is a psychologist at Stanford University. Her latest book is The Willpower Instinct: How Self-Control Works, Why It Matters, and What You Can Do to Get More of It. She is also the author of The Neuroscience of Change and Yoga for Pain Relief.