How Do Your Emotions Affect Your Financial Decisions?

Anyone who has ever been on an emotional roller coaster knows that it can be tough to make logical decisions. The same is true when it comes to our finances.

Research shows that 90% of the financial decisions we make are based on emotions, while only 10% are based on logic. A study by Zaltzman found that 95% of our purchasing decisions occur subconsciously. So we might think we are making logical decisions when buying things when we are not. Our emotions can also influence our investment choices, causing us to take unnecessary risks when we're feeling good or sell off our assets when we're fearful. The logic here is simple; happier people make better financial decisions.

As emotions are a huge part of our daily lives, it's essential to take a closer look at how they affect how we make our financial decisions. In this blog post, we'll explore how emotions can impact our financial decisions and offer some tips for staying rational when finances are on the line.

Who Is A Rational Investor?

A rational investor, or rational behaviour, refers to the "action or decision-making criteria of a person so that the optimum level of benefit is reached." We must be objective when making financial decisions to get the best benefits. However, humans are not robots. Complete objectivity might not be possible. Emotions affect every decision we make.

'Ultimatum Games' Study on How Anger And Disgust Impact Our Decisions

The Ultimatum Games is one of the most influential studies in economics. It was designed to study a simple take it or leave it bargain. The study's premise is simple: Two people are randomly assigned, one as a proposer and one as a respondent and told they would play a game. The proposer will be given a certain amount of money (say $10) and would suggest the amount to divide between her and the respondent. If the respondent accepts the offer, they both get the amount suggested by the proposer, but if the respondent rejects it, they both get nothing. Results of the study showed that if the respondents were offered 40% to 50%, they would accept the money. However, if they were offered 20% of the money, half the time, they would reject it. The number of rejections increases when the offered money falls to 10% or lower.

Most people who got offered a low amount of money rejected it because they were offended that the proposer was stingy. The primary emotions they felt were anger and disgust. So instead of taking the amount they didn't have in the first place, they chose to reject the offer, which meant they both ended up with nothing.

How We Need Emotions To Make Any Decision

One of the most influential studies on how emotions affect our financial decisions was by Antonia Demasio. He studied a patient who had a brain tumour in his frontal lobe. The tumour was removed, but while in surgery, the surgeons re

moved a part of his brain responsible for emotions. This resulted in him having analysis-paralysis. He couldn't decide on anything. Too many emotions might result in us not making any decisions.

Study On Happier People Making More Money In The Longer Term

A study found that college students who were happier than their peers despite not having a job right after college ended up making more money in the long term. On the other hand, there are negative emotions that are associated with making financial decisions. These include:

Anger: You know the saying "don't make decisions when you are angry"? Well, this couldn't be more true when it comes to money. So how does anger affect your financial decisions? One study found that anger was associated with risky financial decisions. But on the other hand, it was positively associated with the willingness to invest money in different stocks, preferring medium/long-term investments, and with high predictability assessment in the forecast of stock trends.

Stress: A study found that stress can have two effects on financial decisions; it can induce harm-avoidant behaviour or increase risky behaviour.

Anxiety: Anxiety combines fear and uncertainty when making financial decisions. When you are anxious, you can either make risky financial decisions or be scared to lose money and end up not investing in stocks that can make you money. For instance, a study found that 30% of people who panicked sale during a down sale never entered the stock market again which resulted in them losing more money.

Sadness: Research showed that when people are sad, they become more impatient. Additionally, unhappy people were more present biased; they wanted something immediately compared to waiting.

Difference Between A 'Maximizer' And A 'Satisficer'

A maximizer is a person who wants to get the best out of every decision they make. They strive to make the decision that results in the best possible outcome. They exhaustively conduct research and invest a lot of time in the process. Satisfiers, on the other hand, are people who are okay with a good enough option, not necessarily the very best outcome. A satisfier experiences less regret than a maximizer even if there is a better option in the future. A maximizer tends to be less happy, regretful and has lower self-esteem. A study found that maximizers might get jobs with a higher salary but tend to second their decision and so end up unhappy. Maximizers also tend to be indecisive when facing too many product options. Whatever options they choose, they think they could have done better. Being a maximizer is great when you have to make big decisions like buying a house or a car, but it's not ideal for simpler things.

Practical Tips On How You Can Manage Your Emotions

If you find yourself stressed or emotional about money, there are some helpful tips you can follow to help you manage your emotions and make better financial decisions.

The first one is to be aware of your emotions. You should be able to name the emotion and why you are feeling it. Then, ask yourself why you feel that way at least five times to get more information and make better financial decisions. The best thing to do when you are feeling emotional is to avoid making any financial decisions. Another thing you can do is consult a third party.

Final Thoughts

For better or for worse, our emotions can have a profound impact on our financial wellbeing. Therefore, it is vital to be aware of this connection and try to make decisions from a place of calm and reason. Although it may not always be possible to remove emotion from the equation entirely, we can make more informed and confident financial decisions by being mindful of their influence.

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