In a perfect world, logic would always guide our financial decisions. Emotions wouldn’t come into play.
But we don’t live in a perfect world. Far from it.
That means our emotions impact our financial choices more than we realize.1
Shockingly as much as 95% of our purchase choices are made subconsciously, driven by our emotions—as little as 5% are based in logic (and that’s when we’re in a good headspace and feeling comfortable and secure).2
When we’re faced with uncertainty, fear and instinct can take over and push logic right out of the window.3
Your brain will make you want to react quickly to protect yourself and avoid the pain you anticipate from potential losses.4
Ironically, these instincts often make things worse. Emotional reactions can lead to poor choices and the losses you were trying to avoid in the first place.5
The best way to avoid letting your hardwired biases take over? Use these strategies. They can help you fare better in any crisis. They may even make you a savvier investor.
Overconfidence is a killer. In fact, research shows that the more experience you have as an investor, the more overconfident you tend to be.6
Stay realistic and grounded by a strategy. Get advice before making big decisions.
Losing money hurts. The truth is that the pain of losses can actually be more intense than any satisfaction from gains. Economists call that “loss aversion.”7 The pressure of anxiety or uncertainty can lead to irrational choices that actually work against our big-picture financial goals.
Don't give into fear or panic when they show up. Focus on logic and rely on your professional for guidance.
Framing is everything when it comes to evaluating performance. That's because the way information and events are presented to us can sway our perception and influence our decisions.8
Look beyond short-term outcomes when framing performance. Think about your longer-term goals and the progress you are making towards them, even when short-term corrections slow your progress.
Recent events usually influence you more than those in the distant past. Why? The human brain remembers recent events more clearly and gives them outsized weight when making decisions. Your brain can mislead you by expecting more of what you've seen already. And that can lead to overconfidence and emotional decisions.9
Resist this tendency by remembering the market is constantly changing. Over the long term, bear markets recover. And no bull market lasts forever.
With decision making, it's natural to focus on one aspect or one piece of information as a starting point. Often, that can greatly influence your final choice. This is known as “anchoring bias,” which can give you tunnel vision. It can lead you to fixate on a single data point, like an investment's price, while ignoring other key information.
To fight it, seek out more information. Think critically about multiple perspectives, and don't forget to consider future potential.
Humans like to make snap decisions. And, when you're stressed out, you're far more likely to make impulsive decisions. The problem is that “gut” decisions are made based on instinct, habit, and emotions, instead of logic and facts. When you're in gut-decision mode, it can be much harder to make goal-oriented choices.10
Take your time when making financial decisions and let your brain shift into analytical mode. With a little time, emotions cool down, and you’ll typically consider more alternatives.11
"We can't foresee or control downturns or upswings. We can only control our mindset, our emotions, and our financial choices."
Markets and economies are never predictable or under our control. We can’t foresee or control downturns or upswings. We can only control our mindset, our emotions, and our financial choices.
That’s easy to lose sight of during periods of economic uncertainty and financial stress.
But, if you can focus on the long game and improve your mental game, you’ll come out stronger and more prepared.
That can make you less vulnerable to hardwired human biases and help you make better financial decisions, no matter what the markets are doing.
As a financial adviser, one of my most important jobs is to help you become a smarter, more capable investor. That involves using psychology and behavioral finance to help you learn more about how your brain works and improve your financial behaviors.
I’m also here to be an objective accountability partner. I talk my clients through emotional decisions, and I can be an important voice of reason and calm when markets are turbulent and it feels like the sky is falling.
If you’re curious about behavioral finance—or if you need a sounding board for a financial decision—I’m here for you. Don’t hesitate to set up a 1:1 call.
I’d be happy to answer your questions and share some more advice.
Steven Chau, CFP® Know Your Worth Financial
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