How emotions shape your financial decisions Emotional decision making during volatile times

To avoid sleepwalking into bad decisions, it’s important for us to understand how our emotions can influence our decision making process. Why do we make certain decisions? What should we be aware of? To answer these questions, we need to dive into how our subconscious mind works.

Common emotions that shape investment decisions

Anxiety – Worrying about what may or may not happen, either now or in the future, can cause our emotions to run wild. Anxiety can be paralysing as we worry over potential ramifications of each decision. Is it the right time to invest? Should I sell to cut my losses? What if I mistime investing back into the market and miss the rebound?

Fear – We can be afraid of what we don’t know and what we can’t control. While fear can serve us well in some situations, like helping us react to danger, it can also prompt irrational decisions in investing, like suddenly selling all your holdings to avoid further losses.

Frustration – If you’re someone who likes to take action, you might feel the urge to “do something” when things go awry. Frustration can often creep into an investor’s thought process. You may act in haste for no other reason than you feel that doing something is better than doing nothing.

Behavioural psychology, heuristics and financial decisions

Behavioural finance is a field of psychology that studies how our emotions, perceptions and experiences can influence, and sometimes bias, our financial decisions.

Aside from the emotions mentioned above, there are some common ‘heuristics’ which can lead us to make decisions which on the surface may seem reasonable but don’t hold up when scrutinised. This is particularly true for periods of market volatility, when quick judgements are often influenced by mental shortcuts rather than careful analysis.

Heuristics are mental short cuts, generalisations or ‘rules of thumb’ that people will subconsciously rely on to make decisions.[1] There’s only so much information our brains can process at one time, so the human brain has developed these shortcuts to enable us to move quickly and efficiently through daily life.

These heuristics can be useful when we need to make fast decisions, but when we apply this to the financial decisions we make, they can cause us to stray from the path of rational judgement. Here are some common heuristics to be aware of:

• Anchoring: Relying too heavily on the first piece of information provided, the so-called ‘anchor’ For example, if you’re in a bad mood or don’t fully understand a subject, it’s easy for your brain to latch onto the first piece of information you hear and base your decision on that, rather than considering all the facts.[2] One instance of this happening could be if markets drop suddenly, the first headline could anchor your view.
• Confirmation bias: Seeking out information that confirms your existing beliefs. For example, if the market is down, you may search for articles that support your belief that it will continue to fall, thus missing an opportunity to invest at a low point because you’re too pessimistic.[3]
• Emotional reasoning: This cognitive bias occurs when we rely on our emotions to make decisions, rather than considering the facts. Think of it like predicting the winner of the Grand National, not exactly a financial decision, but a good example of how emotions can cloud our judgment. We’ve all picked a horse based on something as simple as its name, the jockey’s silks, or even the lucky number on its saddlecloth. Forget the horse’s form or current conditions we just go with that gut feeling
• Volatile periods can often exacerbate herd behaviour.[4]

Lean on your adviser

Keep your emotions in check. Sense-check your thoughts. Speak to your adviser.

That’s what we’re here for.

If you’re reading this article and you already work with a financial adviser, congratulations. Not only do you have a robust yet flexible financial plan in place, but you’ve also partnered with someone trained to help you navigate the emotional and cognitive shortcuts, heuristics, that may cloud judgment. These natural human responses, often driven by the amygdala (the brain’s emotional command centre), can trigger fight or flight decisions at precisely the wrong time. [5]

An adviser can often help you pause, reflect, and re-centre, bringing perspective that’s difficult to maintain when emotions run high. Unlike clients, advisers aren’t emotionally attached to the money in question. They bring training, structure, and experience to recognise when behavioural biases may be influencing decisions and are equipped to guide clients back to a long term, strategic view.

If you don’t currently work with an adviser, it may be worth considering the role one could play in helping you not only plan your financial future, but stay committed to it when your instincts may suggest otherwise.

So, if you do experience any of the above emotions, or if these common heuristics are quietly steering your judgement towards a hasty decision, please pick up the phone.

As financial planners, our job isn’t to tell you how to spend your money. It’s to work with you, helping you make the best financial decisions for your goals and values. This is a collaborative process. And one of the most important roles we play is as your sounding board, especially when clarity and calm are most needed.

This is the part of the job I enjoy the most. We pull the problem apart, we discuss any pros and cons and the likely outcomes, and we then make informed decisions.