Often, it can feel like your rationality and your emotions conflict with one another, especially when you’re making decisions. And, while we’d all like to think that logic will win, your feelings can unfortunately and frustratingly get the better of your thoughts.
Ordinarily, this can be of fairly low importance. You make so many choices in a day that, if you end up making one that isn’t quite right, it probably won’t matter in the grand scheme of things.
But, when it comes to your money, these choices can have wider consequences. A mistake with your finances could be debilitating to your entire financial situation, affecting your ability to afford your lifestyle, and potentially even having an impact on the future.
That’s why it’s important to keep an eye on your emotions when managing your money so that your finances are secure even if you feel like you’re struggling to keep them together.
Here’s why it’s so difficult to manage your emotions and your money, as well as what to do about it.
Financial rationality is a myth
A reassuring point to know if you’ve ever struggled with money and emotions is that financial rationality is essentially a myth. No matter how logical people think they are, heuristics and biases will typically get the better of everyone.
In a study by researchers at Harvard Business School, they presented a choice to a range of retail and professional investors: if a company you hold a stake in is acquired by another firm, what do you do with the stocks you’ve suddenly inherited without intending to?
Logically, according to the researchers, you should sell; after all, you never intended to buy these shares and you don’t know what their value is, so the right choice would be to sell until you have more information.
But of course, that’s not what the research found. Instead, 80% of individual investors chose the default, passive action of holding on, despite this perhaps not being the best option.
Interestingly, some professional investors also chose this approach, too – 30% of what the study calls “institutional” investors chose the same default, passive action.
In the view of the researchers, this shows that when it comes to money, people are “inertial” rather than “logical”; they’ll make the choice that requires no action, even if the evidence is to the contrary.
In essence, what this means is that while you shouldn’t, you inevitably almost always will take the path of least resistance – and so will everybody else.
Missing out on your money
On an everyday basis, the impact of these inertial decisions can start to stack up. You can get stuck in the same patterns because it’s easier to do so than make decisions.
This can see you miss out on opportunities, particularly in investing, simply because it required you to change your habits.
It’s equally straightforward to miss out on opportunities because of the fear of loss, too. This is because of a remarkable phenomenon known as “loss aversion”.
First identified by economists Daniel Kahneman and Amos Tversky in a paper entitled Journal of Risk and Uncertainty, loss aversion is a fear of loss based on past experiences.
According to Kahneman and Tversky, the pain of loss is twice as strong as the pleasure of a gain. As a result, people tend to make decisions that avoid losing over the possibility of a win.
Together, the fear of loss and the inertial approach to money can mean you end up missing out on the opportunity to make the most of your money.
For example, it could stop you from making investments, choosing to save instead as it’s the familiar territory with a lower chance of losing money.
Risk can mean reward with money – but it doesn’t always
Of course, if it’s possible to be illogical by being passive, it naturally follows that it’s possible to be illogical when making decisions, too.
Overconfidence in certain investments can lead you to hold on to them for too long, putting your money at risk even if there are clear indicators that you should choose a different path.
Similarly, you may also become a victim of the “endowment effect”, an extension of the inertial approach. The endowment effect sees you put more emphasis on your prior convictions, rather than new information.
As a result, even when the evidence for a decision is in front of you, your previous experience overrides this and informs your choices.
Overconfidence like this can be just as damaging to your money, driving you to make decisions that put your money at risk, even though it isn’t the logical choice.
Taking on extra risk can be lucrative. But become swept up in the inertia of your prejudices and it can quickly become a problem.
A financial planner can help you manage your psychology
Often, the best thing you can do to help you manage your money without the influence of your emotions is to find support from a professional, such as a financial planner.
A financial planner can provide personalised advice on your money, helping you to see which of your choices are logical and where you’re being overpowered by your feelings.
They can also act as a sounding board for your ideas and decisions, giving you access to two brains rather than one.
By outsourcing to another person, you can remove your prejudices and biases, improving your chances of making choices that are logical, rather than emotional.
Work with us
If you’d like help managing your emotions and finances, no matter your personal preferences for risk or your relationship with money, then please get in touch with us at Bowmore Financial Planning.
Email firstname.lastname@example.org or call 01275 462 469 to speak to one of our experienced advisers.
Bowmore Financial Planning Ltd is authorised and regulated by the FCA
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.