The Gift of Behavioral Finance: Managing Your Emotions

Zoe Team

Dec 12, 2022

7 min read

A financial advisor reviewing a plan with two clients at a table

Key Takeaways

Behavioral finance helps you recognize how emotions like fear and greed impact your investment decisions.
Market volatility often triggers emotional reactions that lead to impulsive selling or buying at the wrong time.
Working with a financial advisor provides an objective perspective to keep your long-term wealth strategy on track during turbulent times.

Frequently Asked Questions

What is behavioral finance?

It is the study of how human psychology and emotions influence financial decisions, often leading to irrational choices during market changes.

Why is emotion a risk to investing?

Emotional reactions to market dips or spikes can cause investors to abandon their plans, leading to poor returns and missed opportunities.

How can an advisor help with emotional investing?

Advisors act as a buffer, offering disciplined, data-driven advice that helps you stick to your goals rather than reacting to market noise.

Wealthquest

How are we expected to manage our financial lives going forward? One of the best tools for managing your finances amid volatility is managing your emotions. According to multiple studies, we make over 90% of our money-related decisions emotionally.

I’m not sure if you are like me, but as this year comes to a close, I’ve found myself asking, “What just happened?” I’ve experienced such a broad range of emotions as I’ve watched the S&P 500 enter a bear market, the bond market experience one of the worst six months in history, and inflation painfully climb. Regarding our money, finances, and beyond, what should we do in this environment as we enter 2024? How are we expected to manage our financial lives going forward?

You won’t get the answer from another tv show on stock picking or an IRS ruling to save on taxes. Instead, the answer might lie where you least expect it. One of the best tools for managing your finances amid volatility is managing your emotions. According to multiple studies, we make over 90% of our money-related decisions emotionally. But what if you need help understanding how these emotions affect your money decisions? In that case, you might be making some crucial mistakes.

Emotions Trump Reasoning?

It’s not all your fault that emotions might lead to questionable decision-making. Again, evolution plays a considerable role. We, as humans, are wired to make most decisions, especially financial ones, based on emotions rather than reason. To make matters worse, we tend to react more, often irrationally, in response to adverse events - a behavioral tendency called loss aversion. For example, studies have shown that we have a far greater emotional reaction to a financial loss than a gain of the same amount. As a result, we often react irrationally following a volatile market environment and make financial decisions that do not serve our long-term objectives.

Fear Should Not Control You

Here’s a recent example. A client called me and said, “I just saw the news that we are in a bear market with a recession coming, and the news said it’s only getting worse. Please put me in all cash.” However, after some discovery, we uncovered the root of his concern: he thinks he will run out of money. In other words, the client admitted he felt scared. Only after I asked, “I understand how you’re feeling, but what are you thinking?” did the truth come out. In his case, fear prompted his need for safety, hence his request for all cash.

In this situation, the client’s financial plan was soundly in place, and there was little chance he would run out of money. What would happen if I reframed the situation and inserted a different thought? “We’ve been through this together, and I remember that we made it through just fine.” He then became overwhelmed by a sense of relief. The conversation suddenly transitioned to one in which we were looking for an opportunity.

Where Does Your Instinct Take You?

Behavioral psychologists have demonstrated that the fear of financial loss triggers the body’s fight-or-flight response the same way that physical danger does. Without these automatic reactions, we would have never survived. Today, it’s hard to escape feelings of fear and negativity, given the 24/7 news cycle broadcasting pessimistic headlines. Yet, we are wired to react as if a lurking tiger we need to run from were nearby. So, when we see on the news that the stock market is free-falling and there is a looming recession, we respond emotionally, which tends to be counterproductive for our long-term objectives. Markets are unpredictable; investors are often best served by an investment approach that involves disciplined inactivity in uncertain times.

Thinking Three Times Before You Act

Understanding how to manage your emotions lies in one fundamental concept: self-awareness. Our brains skip over our thoughts, jump straight to feelings, and ultimately act on those feelings. Psychologists refer to this as activity bias - the human tendency to always want to be active, especially in times of stress. Sometimes you don’t even know what you are thinking - you just do. In the digital age of electronic purchases, it’s even easier to be unaware of the thoughts that cause these feelings. This concept is part of a therapeutic group called Cognitive Behavioral Therapy (CBT). CBT helps us solve problems by bringing awareness and understanding that our thoughts drive our feelings and beliefs. If you pause, take a breath, and try to gain awareness of your thoughts, you will have more control over the emotional response and, ultimately, the result.

Let Go & Gain Clarity

The volatility that has troubled us this year isn’t the first time in history, and it won’t be the last. Understanding that the news, markets, elections, or whatever event occurs are normal circumstances will help bring some rational logic to your decisions. The thoughts you have about a given event are something you can control.

Can You Resist The Impulses Coming from Emotions?

Each of us has a unique money story or script that has developed internally over time. These narratives influence our beliefs about money. We need to be aware of our stories and perceptions to ease the stress these volatile markets can create. Understanding how we develop these beliefs will help bring awareness to our thoughts when that neutral circumstance occurs. Take some time to think about specific times in your life that stick out concerning money. Or ask your family what their thoughts are about money. Their perspectives or beliefs have influenced some of your own.

Whether the market is up or down, being aware of your emotions and behaviors will put you in a more favorable position to achieve your financial goals. Of course, this doesn’t happen overnight, so give it a try the next time you see the latest news post.

Wealthquest

Emotions Trump Reasoning?

Fear Should Not Control You

Where Does Your Instinct Take You?

Thinking Three Times Before You Act

Let Go & Gain Clarity

Can You Resist The Impulses Coming from Emotions?

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