By: Ian Maddox, CRPS®
Letting emotions control our financial plans might not yield the outcome we hope for in the long-term. The late Jim Morrison (The Doors) once said, “I think of myself as an intelligent, sensitive human being with the soul of a clown, which always forces me to blow it at the most important moments.” Morrison got it right. One of the things that makes us human—the ability to experience complex emotions—can also be our unraveling.
All of us have experienced emotion; anxiety, sadness, fear, joy, exuberance, even greed at some point in our lives. Emotions play a role in the decisions we make—with good and, sometimes, not-so-good outcomes. Experiencing fear and running from a mugger in an alley is a good idea. Letting fear, or any number of other emotions, impact our financial decisions too greatly might not be.
There is an entire academic discipline that has emerged in the last decade or so called Behavioral Economics. Behavioral Economics, as the name implies, is the study of why people make the financial decisions they do. Research by Brad Klontz, a Hawaii-based psychologist, co-author of Mind Over Money, and CEO of YourMentalWealth.com, suggests that some people worry about having too little money, others not losing what they have and, in some cases, even feeling guilt for having as much money as they do. Klontz says these feelings are due to something he calls “money scripts”: strong emotions and often unconscious beliefs formulated at an early age that impact behavior.
So if emotions or “money scripts” affect behavior, what are the potential impacts on an individuals or families financial plan?
The chart below shows in very simple terms how prevailing market conditions might impact our emotions and subsequent investment decisions. The black “s” shaped line represents trending market value. In many cases, people increase their investment activity (buying) when they feel best—at the top of the market and reduce their investment activity (selling) when they feel worst. Poor investment timing, however, is just one part of the equation.
Emotions also play a significant role in how we view money and develop our spending habits. Klontz has defined four general categories related to money and beliefs: money avoidance, money worship, money status and money vigilance. Some people actually believe that money corrupts and avoid it all together. In other cases people may see money and the material possessions it can buy as the source of their self-worth. Still, others may be overly cautious and unwilling to take any risk what-so-ever. All of these “money scripts” can skew our financial foundation now or in the future.
If emotions can negatively impact our investment decisions, our view of money, and our spending habits, should we throw in the towel? Maybe not. What we really need is a constructive way to navigate in-spite of our feelings. We need a financial compass.
I think a story might help here. I love to spend time in the mountains. I have hiked many miles and climbed many peaks in the Western United States (Yes, I live in the Southeast, but the Rocky Mountains are in my blood). I cannot think of one time that I have left a trailhead without detailed topographical maps, proper food, equipment, and clothing. Climbing mountains and planning our financial futures are not dissimilar. Heading into the wilderness without a plan is no different than running our financial lives based on “gut” or how we feel. The result of either scenario is likely the same—lost or worse.
You will probably agree that lost is not the ideal state of affairs when it comes to our finances. A financial plan, not unlike a topographical map, can keep us on course. At least it can keep us within range of our course. On many backcountry adventures I have run out of water, gotten sick, dealt with severe weather—even injured (nothing major—knock-on-wood). Time and again—no matter how I felt—the plan brought back a sense of reality. When it comes to our money and our investments, a financial plan serves the same purpose. It establishes reality. We should think of reality as “guard rails.” As in—you’re about to run off a cliff. Guard rails reduce the likelihood we actually do.