The new year often brings great optimism about the 12 months ahead, but when it comes to money, too much optimism can cost you.
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To be succesful financially, tap into the power of negative thinking. It's prudent to lower your money-related expectations or you may find yourself in a financial hole, says Mark Foster, director of education for Credit Counseling of Arkansas, a nonprofit credit counseling agency based in Fayetteville, Ark.
Here are six situations in which optimistic thinking can hurt you and why it pays to be pessimistic.
1. You believe you can pay your debts off faster than you planned. For many people, this is the year they plan to finally become debt free. There's nothing wrong with getting that credit card balance down to zero, but there are pitfalls associated with paying a debt off too quickly. If you pay off your credit cards, but lack a rainy day fund, "if an emergency happens, it goes back on that credit card," says Jana Castanon, a spokeswoman for Columbus, Ohio-based credit counseling organization Apprisen.
Another mistake people make is getting a windfall and making an extra payment on their mortgage or credit card bills when they don't have a financial cushion, says Foster. "If a few months down the road an emergency happens and you can't make your house payment, your lender doesn't care that you made an extra principal payment a couple of months ago."
So think negatively if your emergency fund is on the low side. Slow down that debt repayment plan and use the extra money to build up three to six months of emergency savings instead.
2. You believe good times will last forever. If you've had a steady job and regular promotions, it's easy to be lulled into a false sense of security and rack up debt because you believe you can afford it. However, a job loss, reduction in hours or medical crisis could suddenly reduce your income. "Next thing you know, those low monthly payments that you could easily juggle before are a struggle to make," Foster says.
To avoid financial troubles tomorrow, plan for the worst-case scenario today. Assume that you'll lose that job and will need at least six months to find a new one. Create an emergency fund to reflect that reality. If you don't need it, great. If you do, you'll be financially prepared.
3. You believe loved ones will pay you back when they say they will. Sometimes we're not the ones who are overly optimistic. Rather, it's loved ones we've lent a hand to financially. When Ginger Marcus of Upper Marlboro, Md., lent her nephew $5,000 to help with college tuition, he promised he'd pay $200 per month until the debt was repaid. He had every intention of doing so, but he lost his job in the souring economy and spent nearly two years searching for a new one. Marcus had counted on receiving her money, but the two-year gap in payments taught her to be more cynical of loved ones' claims, even when their intentions are good. Today, she still is willing to lend, but only when she doesn't need the money back. "It's just like playing the stock market or gambling," Marcus says. "Don't lend anything you can't afford to lose."
4. You believe you'll get the same bonus, overtime pay or freelance income. Projecting next year's income is always tricky for self-employed people. If you've had your best year ever, you may be tempted to increase your spending accordingly. However, "if you only focus on your good years, you end up with an overly optimistic picture of what your earning potential is likely to be," says Denise Kiernan, who along with her husband Joseph D'Agnese penned the book "The Money Book for Freelancers, Part-Timers, and the Self-Employed."
Instead, budget for the average income from the past three to five years, while staying alert to earning shifts each quarter and adjusting accordingly, Kiernan and D'Agnese advise. Another way optimism can hurt freelancers: believing clients will pay on time. Stash extra money to cover late payments.
Those who normally receive a bonus or overtime pay often are tempted to count on that money. But your company may cut its bonus or overtime policy, so create your yearly budget using your base salary, Foster says. "If you need that bonus or overtime pay just to get by, then you need to cut back on spending."
5. You believe you'll pay off that credit card before the promotional rate ends. You'll often see promotions for deferred interest deals on appliances or big-screen televisions that promise you won't be charged interest for 12 months or more. Assuming you'll pay it off in time can get you into trouble, since a minor financial setback one month can knock you off your repayment course. In many cases, if you don't pay the balance off in time, you'll be charged interest retroactively. Calculate what you'll need to pay each month to pay the debt off in time, and come up with a backup plan that accounts for the interest in case you don't.
6. You believe your car/appliances/home won't need repairs. Car repairs, house repairs, pet medical bills and appliance breakdowns are not emergencies -- they're inevitable. "When you set up your monthly spending plan, you have to set money aside for maintenance and breakdowns," says Castanon. Look at the last three years of bank statements and add up how much you spent on unexpected bills. Divide that number by 12 and set that much aside each month. If your refrigerator is making a strange sound or you know an appliance is on its way out, put even more money aside. "You need to be realistic and mindful of what you have and what could possibly go wrong," Castanon adds.