We like to think that we’re calm, cool, and rational when we make decisions about our finances. Under the surface, though, there’s a lot more going on, due to the way our brains process and respond to information.
In fact, emotions play a huge, often underappreciated role in our decision-making. Our brains rely on emotional signals to anticipate and prepare for potential threats or rewards. These unseen factors can prompt us to make less-than-optimal investment moves that feel completely logical.
Fortunately, the converse is true too: We can intentionally cultivate emotions that prompt a productive frame of mind, to help make investment decisions that align with our true values and goals.
Understanding our emotional software
The human brain is a prediction machine, says Northeastern University psychology professor David DeSteno, and it uses emotion as an indicator of what’s coming next. But trouble can arise when the emotions relate to something that’s relatively recent in human history—such as investing. Sophisticated as they may be, our brains react very similarly to the deadly threat of a wild animal attack and the important-but-not-lethal impact of a falling market.
For example, fear typically causes us to want to avoid or flee the source of that fear. “With most experiences through human history, that would make sense—but leaving the market when it’s falling often doesn’t make sense,” DeSteno says. “In that sense, the software of emotion hasn’t caught up to the needs of the present.”
Likewise, we may be influenced by an emotion that isn’t relevant to the decision we’re making. Who hasn’t snapped at a partner, child, or pet after a frustrating day at work? These “incidental emotions,” as psychologists have dubbed them, color how we interpret information and make decisions.
The power of gratitude
Our emotions can impact the way we make money decisions. Tap into the power of gratitude to help put you in a positive frame of mind. To get started, take our 2-minute Gratitude Exercise.
The emotional underpinnings of risk tolerance and patience
Emotions can affect 2 key aspects of investing success: tolerance for risk and patience. Our emotions, including fear, are not designed to deal with long-term challenges. When you're calm, you are better able to deal with forward-looking emotional states. Here’s how specific emotions can influence your investing.
Fear and/or anxiety reduce your ability to stomach risk. Whether you’re typically an aggressive investor or you’re more conservative, experiencing fear or anxiety pushes your risk tolerance lower than your personal baseline. That change could lead you to make decisions that sacrifice your potential for gains in exchange for short-term security.
Anger, by contrast, increases your emotional risk tolerance. If you’re making investment decisions on a day when you’re annoyed by your boss or frustrated at your teenager, you may be more willing to throw caution to the wind and invest in ways that are riskier than your norm.
Sadness decreases your ability to be patient—a key factor in reaching long-term investment goals. Delaying gratification is hard enough on a good day. But, says DeSteno, “People who are feeling blue place an even greater value on immediate pleasures—to help them stop feeling blue. As a result, when feeling that way they’re less likely to choose to invest money for the future.”
By contrast, gratitude and pride increase patience levels. When you’re feeling grateful or proud, you become more willing to wait for long-term rewards. Watching your child learn how to ride a bike or thinking about all the ways in which your family is fortunate increases your motivation to make decisions that play out over the long term, such as investing money for the future.
The gratitude hack
How can investors use these insights to their advantage? The first step, says DeSteno, is simple self-awareness: Before making any investment decisions, check in with your feelings. This doesn’t have to be an elaborate process. Simply sit back, take a few deep breaths and assess what emotions you’re feeling. Labeling your emotions will help you understand how they may influence your financial moves in ways that you may not intend.
You can take this practice a step further and actively curate your emotions to foster a productive mindset for investing. Imagine you’re sitting down to do some planning for your family finances, including reviewing your contributions to your retirement savings. First, DeSteno recommends, take a few breaths and reflect for a few moments. Recall a time when you felt gratitude or pride, then reimagine those moments vividly. “Our brain interprets that memory as if it’s happening in reality—and the corresponding emotion will arise too,” says DeSteno. “You can count your blessings or think of things that you and your family are proud of, and your emotions will change within a minute or two.”
Of course, if you’re really angry or anxious, this small hack might not make a dent in your big feelings. In this scenario, DeSteno says, your awareness of your emotional state might prompt you to delay making investment moves until you’re feeling calmer. Then you can summon your feelings of gratitude and make decisions that will benefit you and your family in years to come.