The Role of Emotions in Financial Decision-Making
It isn’t easy to make purely rational financial decisions 100% of the time. This is because our emotions often impact our rationality and financial decision-making process.
Have you ever made an impulsive purchase because you felt down or stressed? Or have you ever stayed invested in a stock or investment that you knew was risky because you were afraid of losing money?
These are just a few examples of how emotions can impact financial decisions.
Research has shown that emotions can cloud our judgment and lead us to make irrational decisions. For example, fear can cause us to sell our investments at the wrong time, while greed can cause us to take on too much risk in search of higher returns. On the other hand, positive emotions like happiness and confidence can also influence our decisions, causing us to overspend or take on too much debt.
If we want to develop a healthier relationship with money, one where we are more in control of our finances then we need to become aware of how our emotions influence our decisions and find ways to balance these emotions with rational thinking.
Here are some tips to help you make more balanced financial decisions:
Get in touch with your emotions
The first step is to identify the emotions and get in touch with the triggers most likely to influence your financial decisions.
For example, you might be prone to overspending when feeling stressed or anxious or taking on too much risk when feeling confident; you might procrastinate on deciding if you feel unsure or lacking confidence.
By becoming aware of your emotional triggers, you can start to develop strategies to manage them.
2. Take a pause
If you're feeling emotional about a financial decision, pausing and stepping back can be helpful.
Our emotions often arise much quicker than our rational and logical thoughts. If you give yourself some time to think about the decision without the influence of your emotions, it can help you to make a more balanced decision.
This could mean waiting for a day or two before purchasing, pausing to take a breath before hitting “purchase’ or just allowing yourself some time to actually consider whether you really need or even want what it is you’re about to buy or do.
3. Consider the long term
When making a financial decision, it's essential to consider the long-term consequences rather than just the short-term benefits.
For example, while taking on debt to buy a new car might feel good at that moment, it could negatively affect your finances in the long run. A choice to spend now, is a choice not to have that money to spend in the future.
By focusing on the long-term, you can make more rational decisions that align with your financial goals. Ask yourself: Would future me, be happy with this purchase? Are they going to be happy to have to make these repayments for this thing I’m buying today?
4. Stick to a plan
A financial plan can help you stay on track and avoid making emotional decisions. Make a plan for the flow of your money in and out of your life. Plan your income, expenses, savings, and investments, and stick to it as much as possible. See if you can build in ways to help you stay motivated and committed to your plan. Can you get a friend to support you, can you make mini milestones and commitments to help you achieve and stay on track.
Feeling connect to, and having a plan in place will mean you'll be less likely to make impulsive decisions that could harm your finances or derail you from the goals you’ve set for your future.
Emotions play a significant role in our financial decision-making, but that doesn't mean we must let them control our decisions.
By becoming aware of our emotional triggers and balancing our emotions with rational thinking, we can make more balanced financial decisions that align with our long-term goals.
Remember - pausing, considering the long-term, and sticking to a plan can all help you make more rational and informed financial decisions!