Wednesday, August 22

The Emotional Roller Coaster - Financial Version

There was a comment on my last post that got me thinking...

"When it comes to money one has to be a lot like the old Star Trek's Dr. Spock. Completely unemotional and totally analytical."
Now that is a tall order! I understand where the commenter was coming from - he wanted to warn about avoiding groupthink and herd mentality. But I think it's an interesting topic anyway. How much do you need to keep your emotions out of your finances?

Well, it depends which emotions and what context they arise in. Some could be highly beneficial. For example, the emotion of fear is well known to be one of the most powerful motivators. Personally, one of my greatest fears is being poor or dependent on others, especially in my older years. So this emotion actually helps me because it is so deeply imbedded in my psyche that even when I make conscious decisions to spend money there is a part of me that is saying "okay, now where can we cut back to make up for this?"

Another emotion that could be financially beneficial is greed. Yes, it can lead to unwise choices too, but many people who chase money above all else actually end up getting it (and often nothing else, but we don't need to get into that!). And especially if greed is matched by a good work ethic, then I think financial success is virtually assured.

However, if you talk about the stock markets, then both greed and fear can sink you pretty fast. They make you sell at the bottom and buy at the top, and make many other stupid moves along the way.

So here's my theory: the context really matters. Emotions are just motivators - they basically cause you to take an action. If you have emotions plus luck or intelligence you get actions with positive outcomes. And if you have emotions plus bad luck or stupidity then you get negative outcomes. In other words, the emotions are neutral but because they motivate action they will expose your strengths and weaknesses much sooner and more decisively.

If I'm right about this theory, then you don't need to control your emotions, you just need to become really smart financially so that every decision you make is a good one. Then when an emotion comes along and causes you to take action, you show off your genius!

What do you think? Are emotions dangerous to finances or is ignorance the real danger??


Frog of Finance said...

I tend to agree that emotions are good action motivators, if controlled properly. The problem is when emotions takes precedence over your financial knowledge and intelligence. When that happens, your decisions become irrational. said...

What do you think? Are emotions dangerous to finances or is ignorance the real danger??

I'd say both are big issues when it comes to investing. Fear and greed are definitely the big ones to struggle with. Knowledge and the conviction in ones actions that results from that knowledge is the best tool for controlling the emotions.

FourPillars said...

Between the two, I'd say ignorance is the biggest problem.

Great post!


Anonymous said...

I also tend to agree that emotions and finances are intertwined. Isn't the desire to be financially independent a base emotion or value that one believes? If emotions and values are intertwined with our financial goals, why not be more explicit about it and consider how our financial planning reflects our values? I think that this is a prime motivator for supports of socially responsible investing (SRI). They want their financial goals to align with their personal values/emotions about the world in which they wish to live...

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...hey, I'm missing your posts! Are you back in school already and too busy reading and writing papers to blog? :)

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Neil said...

Great article. Most people who are in my office are following the herd mentality and aren't making their own decisions. As an advisor I feel it's important to ensure my clients are properly educated in what they are getting involved with regarding their investments.

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Like a bloodied warrior,
laying broken and torn.

Like a dying soldier, hopeless and forlorn.

But the blood, it be green,
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And the soldier is an economy,
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Thanks to the ultra rich and their full proof schemes.

It is a tragedy with more pain to come.

Finance will be Hell, and their wills will be done.

Saver Queen said...

Emotional spending is a huge problem, in fact I would guess that a significant portion of those with big debts are those who get caught in a vicious cycle of emotional spending, or spending to cheer yourself up, relieve tension, etc. Increased debt leads to increased shopping to provide temporary relief. Furthermore, tensions or jealous in relationships can also cause spending problems.

But I think that coming to terms with your feelings about money is a big step towards solving any debt problems that you have. It's not about wiping out those emotions, but learning to fill those gaps in other, healthier, ways. Furthermore, because I believe that curbing your spending requires you to really know what you want out of life, it requires some introspection.

We can't divorce ourselves from our emotions, but we can learn to understand ourselves better, which in turn, can lead to financial decisions that are in line with what we truly desire and need

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Senan said...

I believe investing can be a mechanical process if you are doing it for a living and doing it with other peoples money. However, I don't think it is possible to completely remove emotions from the equation for the amateur investor.

To a large extent we are predicting future growth and earnings and as such historical data is only part of the picture. When we look forward we have to draw on a '6th sense'.

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Chloe said...

I agree with Frog. There are times when it's right to follow your gut instinct, so long as it does not make you careless or irrational

Rajuthan Kirupakaran said...

Emotions are matches to start the fire to motivate you towards your end goal

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Daniel Hanzelka said...

After 16 years as a Financial Planner I have learned on thing the money business is not about money. It is about the relationship people have with money. Recently I have heard a story of an executive that was handling $3 million corporate budget but was not able to balance her own bank account. When emotions and money mix people are not able to cope with it. People need to learn how to detach themselves from their own money and learn how to manage them correctly. Emotions and money do not mix all we have to do is look at what happened during the market correction in 08 and 09.

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