Money and Emotion Continue to be Poor Companions

November 30, 2008 by  
Filed under Investing, Money and Behavior

Do you make financial decisions in moments of panic or other extreme emotion? 

Gotta make an offer on that house before interest rates change?  Must buy that shiny red car on the lot today before someone else does?  Buy that dress, bauble, or gadget to boost your mood?  Quickly sell that stock before the market drops even more? 

There has been plenty of panic-driven money behavior by investors and consumers in recent months.  Often, decisions made under severe stress and/or time constraints do not turn out well.  Panic selling in a declining stock market can reach levels of complete investor capitulation.  That hurts everyone in the market, even those with cooler heads. 

Here is another example of emotion-driven money behavior that back-fired.  It seems that New Englanders – in a panic because of speculation of yet more increases in the cost of heating oil – lined up outside the offices of heating oil suppliers to sign contracts locking in the price.  Unfortunately, this panic set in when heating oil was over $4.00/gallon.  Now the price has dropped below $2.75 per gallon.  Panic has been replaced by oil buyer’s remorse.  Now many of the buyers who hurried to lock-in when the market was high are claiming “rip-off” now that the oil market has fallen.  I can understand that feeling but the primary cause was letting panic influence the initial financial decision.

Similarly, financial planners are reporting seller’s remorse on behalf of clients who, ignoring the planner’s advice, told the planner to “sell everything.”   Larry Swedroe was quoted at the AllFinancialMatters blog about just such an incident:

With Buffett’s insight in mind, I will conclude by relating an incident that was reported to me by an advisor who had done all he could to try and convince his client that he had a well-thought-out plan that anticipated this type of bear market and that he should stay the course. On Thursday the 20th, just before the largest two-day rally in history, the client called to say he just could not take it any more and demanded that the advisor sell everything. He had reached his GMO (Get Me Out) point. On the Tuesday the 25th, following the rally, he called again to admit he was wrong. He admitted that there was nothing the advisor could have said to convince him to stay the course but he has now learned it was a mistake and he promised never to repeat it—he had reached his GMBI (Get Me Back In) point. Let’s hope he does not now get whipsawed. This tale demonstrates the importance of disciplined investing.

Missing out on a rally like the recent four day gain can really hurt.  10% can be a year’s worth of gains in a normal market.

Emotions are natural and in many cases lead to a greater enjoyment of life.  However, in matters of buying, selling, investing, or just plain personal finance, emotion is a problem.  The hard truth is that if you have any ability to be self-aware, you must recognize when your behavior is at risk of being influenced by an emotion you are feeling, particularly when that emotion approaces panic levels.  At that point, your only financial decision should be to delay actually making a money decision until the emotion subsides.  I know it’s hard.  I’ve had my trigger on the “sell” trigger many times in recent months.  I haven’t pulled it yet but the emotional temptation was difficult to resist.

So embrace your emotional side when appropriate.  Just stay away from the mall, the car dealer, and investment account when you do.


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Comments

3 Responses to “Money and Emotion Continue to be Poor Companions”
  1. Nice Article. Emotions definitely trigger a lot of spending but can also trigger good savings as well. Hopefully, in this economy, more people will realize the emergency what-if scenario and it will trigger them to start planning and saving.

  2. Yep, it’s true, people are very emotional when it comes to money. I’ve seen people roll-over when others have hurt them but those same people seem to go ballistic if they think they are out a dollar or two.

    I’m not sure why this is, especially if those same people seem to waste money left, right and centre – I guess it’s because it was they doing it rather than the thought someone else was.

  3. vilkri says:

    Bankers seem to be just as emotional about money as the next person. The guys who are supposed to be so switched on and rational don’t seem to have an idea what kind of loans they had made in the past. Now they are so scared about their own abilities that they withhold loans as much as possible. There was no logic behind extending crazy mortgage to unworthy home buyers. There is no logic behind very strict lending rules now, either. It seems to me that bankers make very emotional decision.

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