Human beings aren’t logical, and it doesn’t take a scientist from Vulcan to prove that fact. A corollary to this statement is that human beings do not make logical decisions when it comes to their personal finances. Consider some things that could happen if people thought about the financial consequences of every choice:
- People would save a greater portion of their income, creating havoc for retailers.
- Consumers would buy only what they need, destroying the market for luxury items.
- The Joneses wouldn’t have anyone following them and might die of loneliness.
- Families would not have children, savings hundreds of thousands of dollars.
- Environmentally conscious options more expensive than the alternatives will not be pursued, causing the planet to eventually perish (sooner than otherwise).
Thankfully, people do not base all decisions on financial rationality alone, and thus our economy, species and planet continue to survive and thrive, although the economy has been taking a beating recently. Emotions and money are linked, but there are some instances when an individual will be better off by separating the two as much as possible.
Investing during a highly-volatile market. Your asset allocation should relate to your time horizon, not react to the current hype in the news. If you had decided that you could withstand short-term market plunges with the goal of a long-term gain through stock market investing, don’t let fear and panic dictate changes when the market dives.
Evaluating products and services. Advertising and marketing are important. This is how a company gets information about its products and services to the public. Every year, the advertising industry advances further, using scientific research that explains how emotions are tied to everyday decision making.
The commercials that you see on television are developed specifically to influence shopping decisions. Even non-profit organizations use your emotions to their advantage; how many times do you see commercials for charities using videos of children who appear to be malnourished and obviously in need of help?
Chances are we’re being marketed to in ways we are unaware. Product placement in television programs in passé, now even presidential candidates are advertising in video games. This is a game the consumer can usually not win. Thankfully there are resources that help us see through the marketing noise, such as Consumer Reports, Charity Navigator, and GuideStar.
Getting out of debt. If you’re in debt, there’s a chance that your emotions led you there. While it’s true that many people are in insurmountable debt due to circumstances beyond control like a medical emergency or a natural disaster, a good portion of people are in debt because they enjoy spending money without thinking about or understanding the financial circumstances.
Some authors and radio show hosts want to have these people get out of credit card debt by playing to their emotions, the cause of debt in the first place. This only solves a short-term symptom, the debt, rather tan the underlying problem, spending decisions based on emotion. It is likely that someone who lets their emotions control their spending as well as their path to reduce their debt will fall back into debt later on. This is why I suggest the “Debt Avalanche” method of getting out of debt. It helps separate emotions from your decisions, a pattern than will help keep you out of debt once you reach that point.
Purchasing a house. I wrote recently about ten tips for buying a house in any market. Ron from The Wisdom Journal wrote in with this comment: “One thing I would add, and it’s very difficult to do, but try to take emotion out of the buying process and especially the negotiation process. Emotions can cause you to pay too much and make a decision that you’ll later regret.”
You want to live in a house that you will like, preferably for a long time. That has to be a part of your decision making process. If you plan in spending a lot of time with this major purchase, it should very well be with a product that makes you happy. The danger comes in the belief that that particular house may be the only one for you. You might fall in love at first sight with your soul mate, but a house is just a house. Don’t get so caught up that you feel you must have the house at any cost and be willing to pay any price to get it.
A better understanding of how your emotions are involved with money is a key to overcoming the influence for certain important decisions as much as possible. Here are a few articles that could help.
When It Comes to Money, Emotions Run High, Psychology Today. “Despite our best efforts, economic decisions can be influenced by emotion. Researchers offer a neurological explanation: The part of the brain that controls negative thinking can often override logical thought…”
The Psychology of Money (series), PsyBlog. “Until recently social scientists didn’t know much about the psychology of money. That has changed with an explosion of fascinating findings on how it affects our emotions, our personalities, our sexual behaviour, our risk-taking and society at large…”
How to Treat a “Money Disorder”, Sarah Kershaw, The New York Times. “Among the problem financial behaviors identified by psychologists in recent years are: overspending, underspending (aka Depression mentality), serial borrowing, financial infidelity (“cheating” on a spouse by spending and lying about it), workaholism, financial incest (lording money over relatives to control them), financial enabling (throwing large sums at, say, adult children who then are not motivated to support themselves), hoarding, and plenty of guilt and shame around poverty and wealth…”
Emotions are intricately linked with the financial decision making process, and are in fact necessary to make the correct choices in many situations. Even a small effort to put feelings aside in certain circumstances and think rationally could go a long way towards improving the quality of those decisions.
Updated February 10, 2011 and originally published October 20, 2008. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.