The science behind money and emotion
How to make better financial decisions
Have you ever gotten emotional about money? Even the most successful, rational investors sometimes (or often!) experience feelings of anxiety or euphoria when their money is involved.
Why? You’re human.
Emotion gets a bad rap when it comes to investing or other financial decisions. In fact, a lot of experts will tell you to remove emotion from investing. But that’s not really possible—and not really necessary.
“Especially in stressful times (and let's face it, between COVID and inflation, it feels like there's a lot of worry in the air lately), what's important is that you're aware of emotional triggers and how they can affect you,“ said Chuck Riley, a senior wealth advisor certified in financial psychology and behavioral finance.
What happens when you make a decision?
Behavioral economists, psychologists, neuroscientists, and others are doing research every day to learn more about how we make decisions, including important financial decisions.
Researchers in neuroeconomics, an outgrowth of behavioral economics, have found that rational, logical decisions are controlled by the prefrontal cortex. And when we're making decisions based more on emotion, the limbic regions of the brain are in control.
Hormones also play a part. When we're faced with making a choice, the stress hormones cortisol and adrenaline are released.
Interestingly, it turns out to be a bad idea to try making decisions based solely on logic—patients with injuries to the parts of the brain that integrate emotion and thinking repeatedly make objectively bad decisions even though their cognitive faculties are intact. The research suggests that emotions play a necessary role.
Emotion and investing go hand in hand. After all, emotions often motivate us to save. Love for our families, a need for security, and our hopes for the future are all powerful drivers when it comes to investing.
How do you know when emotion is leading you in the wrong direction?
So we know emotion and logic need to work together when you make choices. And we'll share some tips for balancing them. But first, here are a few things to watch out for.
Remember that emotions relating to one event can influence your decisions elsewhere. For example, a disagreement with a loved one, a promotion at work, or an upcoming reunion could all spill over into your investment decisions. (Researchers have correlated stock market performance to everything from the amount of sunshine on a given day to a country's elimination from World Cup soccer.) This might be especially relevant in today's world, when many of us have our anxiety turned up on a daily basis by pandemic developments.
Be aware when you're faced with content intended to provoke an emotional response. News headlines get more attention when they appeal to feelings like fear. If you're seeing stories about, say, soaring inflation, consider the facts and whether taking action would actually be helpful or just part of an emotional response.
Finally, remember that it's not just “bad“ emotions that can burn you! For example, if you're feeling extremely confident, it might lead you to take more risk. Behavioral psychologists have found that this connection can be especially powerful after a “near miss“—when things almost go horribly wrong but come out okay, leading you to feel invincible.
Emotion and investing go hand in hand.
After all, emotions often motivate us to save. Love for our families, a need for security, and our hopes for the future are all powerful drivers when it comes to investing.
Acknowledging that our emotions are part of what drives our behavior and comfort level with investing is valuable. To anticipate how emotions might affect your investing behavior, ask yourself questions like these:
Strategies for balancing emotion and logic
In their research, psychologists have found that the most obvious strategy—don't get emotional—doesn't work. So what does? Here are a few research-based tactics you can try.
Flip the script. Reframing decisions can help you focus on positive emotions. For example, many retirees are hesitant to spend their savings—they may be worried about seeing their balances decline or feel guilty about becoming a “spender.“
“If I sense hesitancy on the part of my clients to spend from their savings, we dig into why that's the case,“ Chuck explains. “Things like the way money was handled growing up, or traumatic financial events like a job loss or death of a spouse, can weigh heavily on someone's money perspective.“
“Even if those circumstances are completely different now, they can subconsciously undermine success. So once we've surfaced those emotions, we can come up with a new script—I deserve to enjoy what I've worked hard for or I'm still responsible with my money, but now it's reflected in different ways.“
Enact a waiting period. Emotions may have evolved to draw attention to situations that demand immediate attention. They certainly can make any decision feel urgent and critical. Many people find that they can and should reevaluate their thinking once they return to their calmer baseline—which is almost guaranteed to happen given a little time.
Know thyself. Mindfulness, meditation, and journaling have become increasingly popular lately, but knowing your own mind has been a solid piece of advice since Socrates' time. Research has shown that people with high “emotional intelligence“ (being aware of and using emotion to enhance thought) are better at screening out the effects of emotion when making decisions. You can get more in tune with your thought patterns in any number of ways, so do what works for you.
Be accountable. When people know they'll need to explain and defend their decisions to someone else, they naturally focus on the rational reasons for the decision and minimize the emotional ones. “Having a trusted sounding board can help you ensure your logic is as solid as possible. This is potentially the most important role I play as a financial advisor,“ Chuck says.
Work with your emotions
Learning more about what influences our behavior is a great first step in recognizing when we're making decisions based primarily on our emotions rather than on logic and reason.
But we shouldn't discount our emotions—they play an important role in investing. After all, they're often what drive us to invest in the first place: love for our family, hopes for their future and ours, pride in our accomplishments. Harnessing those emotional drivers can help motivate us to save.
of the value an advisor provides their clients is emotional—feelings of confidence with their portfolios, satisfaction with their choices, and excitement for the future.*
“As an advisor, I respect how important my clients' emotions are. In fact, Vanguard research has shown that about 40% of the value an advisor provides their clients is emotional*—feelings of confidence with their portfolios, satisfaction with their choices, and excitement for the future,“ Chuck says.
So go ahead and feel your feelings. And balance them in whatever ways work best for you.
*Source: Vanguard, “The value of advice: Assessing the role of emotions,“ March 2020.
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