Ray’s Take As if the complexities of stocks, bonds, and other investment options weren’t challenging enough, our own bodies can push us into poor financial decisions. The study of neuroeconomics – a discipline that encompasses economics, biology, and psychology – has determined that our brains simply aren’t hard-wired to make rational decisions involving risk. And, investing is all about risk management in one form or another.
For example, studies show that investing in foreign markets excites the fear center of the brain simply because “foreign” feels less familiar. This is in spite of the fact that foreign stocks are less correlated with domestic stocks and actually reduce overall risk. On the flip side of the coin, people feel the least fear when investing in the company where they work. Neither investment decision is based on rational thought or dispassionate analysis, yet it’s often feelings like these that shape portfolios. Even though your rational brain may be telling you it’s not a good idea to invest a lot of money where you work – too many eggs in one basket – your gut feelings are pushing you to do just that.
Then there is “irrational exuberance,” a phrase coined by Alan Greenspan to describe the dotcom bubble. When you make a stock purchase or other investment that surges in value – whether by luck or skill – you get a rush of adrenalin that increases your confidence and pushes you to take even greater risks. There were plenty of times in humanity’s history when that extra boost of confidence was useful for survival, but not when it comes to making investment decisions.
There’s even evidence that certain genes work against us: People with longer serotonin transporter genes tend to be more impulsive than individuals with shorter ones.
The goal with investing is not to experience a rush thanks to a strong-performing investment, nor is it to feel all safe with familiar investments that don’t arouse fear. The goal of investing is for your money to earn money at a reasonable return while reducing risk through diversification.
However, when the very things that make you human work against wise investment decisions, what can you do? Ask your financial adviser.
Dana’s Take Emotions like anxiety and depression can drive “retail therapy.” Ironically, some people spend money when feeling stressed about excess debt – a vicious cycle.
The Internet and smartphones make it even easier to soothe uncomfortable feelings with instant purchases. By the time the merchandise arrives, the mood has passed but the balance remains on your credit card.
Any behavior we pursue in order to avoid feelings can lead to addiction. Is spending causing you problems at home? Have you tried to stop but can’t?
The first step toward recovery is to admit that you have a problem. Talk to the people you’re hurting with your spending and seek help.
Before emotional spending costs you the people you care about the most, ask for help.