“Well-being is attained by little and little, and nevertheless is no little thing itself.” – Zeno of Citium
People are emotional. Emotion is an integral part of being human. Much of what we do and the decisions that we make are guided by our emotions. Sometimes this works out well, but it can also work against us, especially when it comes to money decisions.
Economists used to believe that people primarily make rational financial decisions, but they have come to realize that emotions play a significant role.
NOTE: The psychology of economic decision making is called “Behavioral Economics” (see “What is Behavioral Economics” by Shahram Heshmat Ph.D. at PsychologyToday.com).
So, what can we do to guard against our emotions from negatively impacting our personal finances?
1. Put good financial behaviors on “auto pilot.”
Studies have shown that setting up an automatic deposit into your savings account and/or into your retirement plan (or both) are very effective ways to build financial assets. If the money is set aside before you see it in your paycheck, you are much less likely to spend it on impulse.
2. Take time to decide.
Establish a dollar amount (like $100) over which you won’t make a purchase unless you take at least one day to consider whether you need it or not. Often, taking even a single day to think about a purchase will help take the emotion out of the decision.
3. Don’t check “too often.”
Once you have done the appropriate homework to establish your investment plan (i.e. investment research, working with a reputable advisor, etc.), don’t check the balances “too often.” This is especially true if you’re prone to overreacting to market fluctuations.
That doesn’t mean to ignore your portfolio or not to periodically evaluate that your plan is still appropriate for your circumstances. Just don’t check so often as to make yourself vulnerable to emotional investment decisions.
4. Leave the credit card at home.
Studies have shown that you are much less likely to make an impulse purchase if you have to pay cash for that item. The convenience of credit cards makes them very susceptible to our emotional impulses.
Of course, emotions aren’t always bad. Anger at injustice motivates us to take action against unfairness. Fear of injury and loss helps us avoid excessive risk and dangerous situations. Compassion moves us to help those that are less fortunate. Love is often its own reward.
Emotions can even help guide our decision making, especially when we don’t have any better information or we are forced to make a decision quickly. The problem occurs when our emotions cause us to take actions that damage our happiness and personal finances.
We can minimize “emotional risk” to our finances by putting good behaviors on automatic, taking time before making significant purchases, not checking on our portfolios “too often,” and leaving our credit cards at home.
Joel Fink is a retired CPA and financial services executive living in Dallas, Texas. He enjoys writing articles that help real people with simple ideas to manage their money and improve their lives.