Finances are typically considered a matter of the mind, not the heart. Whether we're creating a budget, or picking a stock to invest in, we tend to see financial considerations as more logical and rational than other categories of decisions we make throughout the week. After all, most people agree we need to be smart when it comes to money—or else we will literally pay the price of ignorance.
Decisions about money are the perfect example of how practicing what one preaches can be extremely difficult. Emotions are a primary driver of decisions, in that we tend to feel positive or negative about something immediately—it's only later that we try to develop reasons or arguments to support this feeling.1
The feeling-first model explains why it’s so difficult for us to walk away from a new pair of shoes we love at the store or say no to a night out with friends when these purchases are not in our budget. The planner in us knows it is the logically incorrect decision, but the feeler in us wants nothing more than to say yes.
Here are some of the biggest emotions driving your financial decisions, and how they work.
1. Fear
Fear is perhaps the most powerful emotion when it comes to shaping financial decisions. Research has found that the fear of losing $100 is significantly stronger in magnitude than the excitement of winning $100, a concept dubbed loss aversion.2 Panic buying, which was on full display during COVID, is fundamentally driven by fear. All logic goes out the window, and fear leads people to buy all 20 bottles of hand sanitizer that Target has on the shelf.
The insurance industry is fundamentally fueled by fear. Insurance companies make money by, on average, changing customers more money in premiums than what the company must pay out in claims. However, we all happily purchase insurance to squash any fear of completely losing our home, car, or iPhone even though this insurance is a losing bet on average. Fear also manifests itself in business and investing—dissuading some people from starting their own businesses or investing money in the stock market, or leading them to pull money out of the stock market at the first sign of a downturn.
2. Greed
The emotion of greed can drive us to take on excessive risk in the pursuit of glamorous fortunes. Compared to other emotions, greed tends to be more rational or calculated.
Research finds that if you give people money and offer them the opportunity to share this money with someone or keep it, our spontaneous gut reaction is to be generous and share. However, if you allow people to think deeply about this decision, people tend to make greedier decisions.
While fear leads us to overestimate the odds of negative outcomes, greed can lead us to underestimate these odds. Greed promotes get-rich-quick thinking with money—leading to such behaviors as gambling, investing in cryptocurrency, and buying lottery tickets. (Some economists refer to the purchase of lottery tickets as a tax on the stupid—a fact I’m often scowled at for sharing with my friends). The emotion of greed can also lead people to overlook any downsides or risk, focusing only on the potential upsides—fantasizing about what it would feel like once you “hit it big”.
- What Is Fear?
- Take our Generalized Anxiety Disorder Test
- Find a therapist to combat fear and anxiety
3. Anxiety and depression
Anxiety and depression operate differently than fear and greed. These emotions will often lead to what behavioral science calls “decision paralysis.”3
Because it often stems from instability in a relationship, a problem at work, or the negative results of another financial decision, experiencing anxiety and depression often leads to neglecting decision-making when it comes to personal finances. Putting off choices can be a positive thing at times—for example, it can help prevent impulse purchases. On the other hand, decision paralysis can have negative consequences such as waiting too long to start investing in a retirement account or neglecting to pay off debts with nasty accumulating interest rates.
How to Make Better Financial Decisions
Financial decisions, just like any other decision you make, can come from the head or the heart. Try asking yourself and others questions such as the following:
- Is this an emotional or logical decision?
- Are my emotions causing me to be too cautious and miss out on a good opportunity?
- Are my emotions causing me to be too excited and overlook the risks of a given opportunity?
- Is decision paralysis making an unpleasant situation even worse?
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At a meta-level, understanding how emotions can impact financial choices is powerful. Next time you’re at a crossroads with a financial decision, ask yourself what role your emotions might be playing to help make the best choice possible.
References
Haidt, J. (2001). The emotional dog and its rational tail: a social intuitionist approach to moral judgment. Psychological review, 108(4), 814.
Kahneman, D. (2011). Thinking, fast and slow. macmillan.
Schwartz, B. (2004). The paradox of choice: Why more is less. HarperCollins Publishers.
FAQs
Emotions impact financial decisions often more than logic and reason do. Fear can lead us to play it safe, while greed can cause us to overlook risk. Acknowledging the role emotions play in your choices can help you make smarter financial decisions.
How do emotions impact your financial decisions? ›
But there's another factor that can have a huge impact on how you manage your money - your emotions. Emotions are sneaky and can influence logic and reason, risk tolerance, and the choices you make. They can have a positive or negative impact on your finances.
How are your emotions impacting your decision-making? ›
Decision-makers who feel more upbeat tend to be less focused in their information search. Anger, on the other hand, can undermine good decisions. People who experience anger, the researchers found, are prone to take greater risks.
What is an example of an emotional experience that can influence a financial decision? ›
Emotions also play a significant role in financial decision making. Fear can lead us to make hasty decisions, such as overspending or accumulating high debt, without properly tracking our expenses or living within our means. Our past experiences with money can also shape our financial behavior.
What is true about emotions and financial decisions? ›
The Impact of Emotions on Financial Decisions
A study performed by Nobel Prize-winning psychologist Daniel Kahneman showed that we make financial decisions based 90% on emotion and only 10% on logic.
What is the significant role of emotion in individual financial decision-making? ›
Emotions and Risk Tolerance: Emotions such as fear and greed can greatly influence our risk tolerance. When individuals are driven by fear, they may become more risk-averse and opt for safer investment options. On the other hand, feelings of greed can lead to excessive risk-taking and speculative investments.
How do emotions affect people's relationship with money? ›
Our emotional ties to money, often shaped by early experiences and traumas, play a significant role in our financial habits and decision-making, and understanding and addressing these emotional connections can be a crucial step toward achieving financial peace and success.
How to balance your emotions and reasons when making decisions? ›
Develop self-awareness so that you can recognise your own emotions and how they may affect how you make decisions. Know your triggers, biases, and how emotions may affect your decisions. Don't make any snap judgements. Recognise the context, give it some thought, and then decide after thoroughly analysing.
What are the 7 factors that influence a decision? ›
7 Factors and Personal Characteristics That Have an Impact on the Decision Making In an Organisation
- Programmed versus non-programmed decisions:
- Information inputs:
- Prejudice:
- Cognitive constraints:
- Attitudes about risk and uncertainty:
- Personal habits:
- Social and cultural influences:
Most people do not realize how much their emotions direct their moral choices. But experts think it is impossible to make any important moral judgments without emotions. Inner-directed negative emotions like guilt, embarrassment, and shame often motivate people to act ethically.
Personal circ*mstances that influence financial thinking include family structure, health, career choice, and age. Family structure and health affect income needs and risk tolerance. Career choice affects income and wealth or asset accumulation.
What are the influences on financial decision-making? ›
Internal and external factors are the two types. Internal factors include the nature of the firm, its size, its structure, and the structure of its assets, among others. Economic conditions, tax policy, government regulation, capital structure, and financial markets are all examples of external factors.
What is an example of making decisions based on emotions? ›
100% of decisions are emotional.
- Health decisions like eating right and exercising.
- Having difficult conversations with co-workers or people you love.
- Practicing new skills for your job.
- Doing difficult but necessary tasks.
- Self-awareness and ego.
- In most situations I believe you know what to do.
Emotions impact financial decisions often more than logic and reason do. Fear can lead us to play it safe, while greed can cause us to overlook risk. Acknowledging the role emotions play in your choices can help you make smarter financial decisions.
How our emotions affect our decisions? ›
Emotions, especially at a high intensity, impact our ability to make rational decisions. Strong emotions can impair our judgment and make it challenging to think objectively and critically. This is why it is important to temper our emotions to be balanced and proportional to the situation.
How do emotions factor into investment decisions? ›
Fear and greed are powerful emotions that can lead to irrational investment decisions. Fear of losing money can lead to overly conservative investment choices or even avoiding investing altogether. Greed, on the other hand, can lead to excessive risk-taking and speculative investments.
How do emotions affect the economy? ›
According to behavioral economics (BE), emotions play an important role in an individual's decision-making process. For example, if consumers become more optimistic regarding the future, then this is going to send a message to businesses regarding investment decisions.
Are 90% of decisions based on emotion? ›
The influence of emotion
Even if you think your decisions are based on logic and common sense, the reality is they are often steered by emotion. A study performed by Nobel Prize-winning psychologist Daniel Kahneman showed that emotions contribute around 90% to our decisions, while logic only factors in for around 10%.
Why is emotional finance important? ›
Emotional finance explicitly sets out to examine how our emotions, both those of which we are conscious and more importantly, those unconscious, play a key role in all financial decisions.
