More often than not, people tend to use their emotions over their minds to make their financial decisions. When it comes to our money, how often do you find yourself falling prey to your feelings instead of using your head to dictate your actions? Behavioral finance is that branch of finance that dwells upon topics like these, as it tries to explain away why people act and behave the way they do when dealing with their money.
Image from The Chess Piece
Develop Financial Strategies Without Emotion
Based on observations I’ve made of others during my life, I’m finding that the average citizen is generally unaware of the role of emotions in his/her financial decisions. If my daughter seeks economic refuge in my home after losing her job, will I reject her? Of course not. My love for her will tell me to help her in any way I can.
But what is the role of emotions when deciding to buy stock? I have already mentioned in previous articles that anybody under 40 should jump into the stock market and take advantage of low prices for very valuable companies. If you’re young enough, you can afford to wait 20 years and make a killing, but you can also afford to be wrong and rebuild. Is emotion a huge factor in this common sense decision? No, rationality tells you that the market will eventually recover. The only emotion you should have should be your excitement 20 years from now when you cash in and secure your retirement.
Do You Make Financial Decisions With The Herd?
Now there’s also this thing called the “herd mentality”, which is described as the tendency for people to act in unison (“as a herd”) when certain events trigger their behavior as a group. As they say in the financial world, there are twin emotions that govern how the markets behave: fear and greed.
When greed takes hold, few money managers become interested in selling their equity holdings in a market that seemingly continues its upward momentum. And when fear takes root, the same thing happens pretty much, with investors the world over deciding to unload their holdings all at once. Now whether these moves are right or wrong is not the issue, but whether such moves are due to peer pressure or the herd mentality. Are you investing in the stock market? If so, are you one of those following the herd or are you capable of bucking the trend and making your own decisions?
Why Emotions and Money Don’t Mix Too Well
So before you make any moves, consider all your options. Before you make any purchases or investments (real estate, shares, retirement investments) look into all possible alternatives and not just the option that you feel that you have an emotional attachment for.
I think that some self-reflection can help. When facing a financial decision, ask yourself a few questions. Are you the kind of person who will invest “because a friend who’s in the know gave me some tips”, or have you done your homework before deciding on any major expense ($1,000 or more)? You should ask yourself whether your decision is based on emotion or facts, a difficult process indeed.
Some experts argue that women may be strongly influenced by aesthetics (oh what a pretty color on the car), or by the seller (he looks like such an honest man), or by the overall distribution of the house (look at that beautiful kitchen), while men are supposedly more rational. Well I think that this is a bunch of crock. I have made my share of bad and good decisions based on emotional attraction, as much as my wife has.
Extreme emotions are bad advisers in any situation. Never make an important financial decision on the same day you meet your dilemma face to face; let your pillow help you analyze the matter, then reach your resolution with a cool and rested head (and heart). Remember that there are many scammers out there who want to empty your wallet while filling theirs. In case of doubt, stay away from the good deal; it may just ruin you!