Emotions Have a Huge Impact on Financial Decisions

When we think of emotions, the idea of personal finance doesn’t typically enter our minds at the same time. But because we are emotional creatures, it’s impossible to separate the two.

The reality is that our negative emotions are costly. They can cost you the retirement you deserve and your financial peace of mind.

We’ve all heard the phrase Retail Therapy for those who shop when they feel down or stressed. Or Binge Spending, which can occur in a fruitless attempt to fill an emotional void.

And the biggest of all, our human nature driven urge for Instant Gratification. We want it and we want it now!

What’s less apparent is the financial impact of other emotions, psychological conditions, and emotionally charged situations.

There are too many to list, but things like addictions, hoarding, relationship conflicts, childhood trauma, impulsive behavior, insecurities, revenge, and greed are just a few.

Emotions are what makes us human and they silently guide our decisions, often in the wrong financial direction. The fix starts by simply acknowledging the potential negative impact.

Those who don’t realize the finance and emotion link don’t have a chance of recognizing and addressing repeat patterns that may be undermining their best financial intentions. They simply don’t realize that negative emotions are costly.

Some of the emotions and situations that hurt us financially can easily be neutralized, but others may not have an easy — or any — solution.

The objective isn’t to necessarily suppress all our emotions, but to instead recognize the link and put tactics in place to reduce or eliminate the damage.

My aunt and uncle’s finances were hurt deeply by negative emotions and relationship conflict.

One example was my uncle’s passion for boating. While my aunt’s interest in boating never reached the same level, she found a way to live with the time and cost commitment, and extract at least a little enjoyment.

Unfortunately, later in life, resentment for the financial impact built until it exploded.

Rather than reach an agreement on how to handle the conflict, her reaction was to go on a multi-year spending binge. One facet was buying thousands of dollars of TV shopping network items for which she had little use or space.

An emotional response to be sure, and a shortsighted one was well.

They both were in the same financial lifeboat and her actions hurt her as much as him.

She openly acknowledged her activity. When she and I talked about it and we discussed the mutual damage, her response was “I don’t care, it’s time for me to get mine after all the money he wasted on boating.”

In this case, her desire to settle the score fueled emotional spending that help deteriorate their finances even faster.

On the same topic of boating, my uncle’s emotional decision making cost them over 20% of their remaining net worth at the time.

My aunt had an unfortunate medical event that resulted in her becoming a paraplegic.

Despite the reality of the situation, my uncle held onto their boat she could no longer board, and that he would therefore no longer use.

While after two years he resigned himself to selling it, his reluctance caused him to set the price so high that there were no buyers, and then the Great Recession hit, drying up the market altogether.

He ended up being stuck with a boat he didn’t use for 6 years. The increased carrying costs (annual dockage, storage, winterization, maintenance), and the reduction in sales price versus selling it years earlier, cost them nearly $40,000.

His emotions, anchored to their better days of when they could use the boat together, drove him to a financial mistake that cost them dollars they could not afford to lose. And despite the delay, the outcome was the same, he had to sell it.

While these examples were unique to their relationship, no one is immune.

Emotional decision making can be on its most painful display in the stock market, especially when markets tumble.

Markets are driven by two forces: greed and fear. Fear is unquestionably the most powerful of the two.

Anyone who doubts this only needs to look at the price patterns of bull versus bear markets.

Bull markets tend to rise gradually over a long period of time. Greed is a strong force, but it’s somewhat more orderly and gradual.

Bear markets are shorter, but most are characterized by sharp falls that are more extreme than the moves when the market rises.

The reason is that fear powers investors to head for the exists more urgently.

Studies have shown that losing money feels twice as bad to us as making money feels good. Simply part of our human nature.

So what’s a savvy investor to do in order to counteract the potential destruction of emotion? Quite simple. Take the emotion out by relying on automation.

Automating your investing simply involves always following a previously determined set of rules.

For instance, in buying an individual stock, before the purchase is made there should be predetermined rules for how much you’re willing to lose. Ideally it’s no more than 10%.

Hit that loss point and the investment is sold automatically. No if, ands, or buts. The automatic selling can be achieved by what’s called a stop loss.

Without a predetermined game plan, what happens is that, as your stock falls, emotion takes over. You may end up staying in way too long. Stocks can go to zero. The losses can be massive.

When my aunt and uncle put their investible liquidity into high risk investments, a stop loss for their account would have saved their neck.

They eventually got out, but they’d lost 50% of their original principal. This was financial devastation. They would never recover.

What’s more challenging than setting investing rules is compensating for emotional conditions. In the case of my aunt, she lived her last decade in the firm grips of a severe hoarding disorder.

In her case, the underlying causes were many, and not easily resolved. But until the very end, when she was forced, she refused to acknowledge the condition or its effect.

The signs were obvious.

Their 1200 square foot home, with full basement, become completely impassible. In the last few years I couldn’t even stop by to bring food over and share dinner because there wasn’t an inch of room on the kitchen table or even a spare chair for me to use.

All chairs were used as shelves for holding more stuff.

When my uncle became ill with end-stage liver disease, he collapsed at home and my aunt called 911. The EMTs could not get a stretcher into their home so they were forced to carry him out on a sheet. How sad.

When my aunt went to see him at the hospital, Social Services approached her with the “We need to talk” speech.

They told her it was reported that her home was unsafe for a paraplegic. Given the situation, they gave her 30 days before they would do a formal inspection. They gave her a referral for a psychologist who specialized in hoarding disorders.

My mom attended the first session.

The psychologist asked the same question 6 different ways: “Are your possessions more important than the people in your life?” My aunt’s answer was unwaveringly yes. That’s the unfortunate vice-strong grip hoarding can have.

In my aunt’s case, many of those possessions included recipes she clipped in 1982 that she never made, and broken appliances from the 1970s. She added to her stash by buying duplicates upon duplicates for things she never even used.

Food stocks expired and some jars were so old they exploded in her cupboard.

All in all, a very sad situation, with a huge emotional toll for her, my uncle, and family that could no longer visit because her hoarding consumed her life and home.

But beyond the emotional toll was a financial one. Her hoarding spiked when their finances were the most fragile. Tens of thousands spent on overshopping and unneeded items did not help improve things.

Hoarding is just one example.

Even more emotionally and financially devastating illnesses are the addictions of drugs, alcohol, or food.

Addictions can hurt you financially in three ways: they can damage your ability to generate income, feeding the addiction can consume some or all of your cash, and your health can quickly deteriorate.

In the worst case you can even end up in prison or dead.

Of course addictions have many causes and are notoriously difficult to resolve, but management and even cure is often possible with a strong commitment and the right treatment.

How sad would it be to sacrifice the secure retirement you deserve because you had an addiction that went unaddressed during your peak earning and saving years.

Finally, emotions that most experience from time to time, like jealously, insecurity, comparison to others, and impulsiveness, can all have nasty financial impact, usually on the spending side.

Some self-medicate by buying things to make themselves feel better, because someone else has the same item and they think they should too, or because they had an impulse that the item would make them happy.

The reality is that most purchases made in that manner never permanently resolve the negative emotion. Any relief is temporary. But the financial damage is permanent.

Many bankruptcy-causing credit card balances are built one emotional purchase at a time.

Make no mistake that we all need occasional splurges. But savvy wealth accumulators plan them in advance, save up in order to pay cash, and keep them in proportion to their financial goals.

In fact those occasional splurges can be better than none at all, as they provide a taste of the rewards of reaching the financial goals, including a secure retirement, that you’re working toward.

The bottom line is this: we humans will always have, and be driven by, emotions. Recognize that negative emotions are costly. Some will have even deeper conditions that take a significant toll. Resolve them when you can but, in all situations, move quickly to limit the financial damage.

Neutralizing emotions may be hard, but you’ll be glad you did. Your financial future depends on it!

⇒Next: 4. Relationship Turmoil Affects Finances