I want to introduce you to a species of human you’ve probably never heard of before: Homo economicus. If there was a perfect investor, Homo economicus would be it. He knows everything there is to know about every company, country and market. He is motivated by self-interest and isn’t swayed by the needs of others. Best of all he always acts rationally.
Choices are simple for Homo economicus. When faced with how best to achieve a goal, he would calculate the optimal path and follow it without deviation, hesitation or regret. The complete absence of emotion is the reason he is successful and the reason he does not exist outside of finance theory.
Although we often make choices thoughtfully using our rational minds, we can’t ignore the impact of emotions on our financial decisions. Take for example the way many of us behave in response to stock market fluctuations. When things are going well we generally feel good about investing and are inclined to buy more stocks. When the market is going south, we generally feel fear and anxiety that might even drive us to take our money out of the market completely. This is exactly the opposite of what Homo economicus would do because he knows that you want to buy stocks when the prices are down and sell them when prices are up. That’s a much easier plan to follow when neither confidence nor fear have any influence on your decisions.
This certainly isn’t to say that the best financial decisions are made without regard to our emotions. We will never be able to extricate emotions from our financial decisions entirely, nor would we want to. They are what motivate us to do things that aren’t wholly self-motivated, like providing an education for our children or donating to worthy causes. They are what cause us to choose retiring to spend time with family, rather than working one more year just to see the bank balance go up.
What we find is that the best financial decisions are made when there is a balance between what is reasonable and what satisfies us emotionally. In order to strike that balance, we must understand the emotions that influence our financial choices. Without that awareness, our emotions can become the primary driver of our decisions, often times without us even realizing it. When that happens, just like in the stock market example, we can actually make choices that are counter-productive to what we want in the long run.
I recently went through an exercise designed to focus on some of my emotions, specifically fears, about money. Initially I thought focusing on them would make me even more susceptible to their influence, but I found exactly the opposite to be true. This exercise is designed not only to help you think about your fears, but actually think through what would happen if those fears came to fruition.
It wasn’t easy. When I began the exercise, I could feel my anxiety building. It was difficult to think about what I could lose if my financial fears became reality, but I also started to realize what no financial hardship could ever take away: my marriage, my knowledge and skills, seeing my dog’s face when I come home. I also stopped focusing purely on if the worst might happen, and started thinking about what I would do if it did. I figured out a path forward and that gave me some relief.
In the spirit of finding the balance between our rational and emotional selves, I encourage you to take a few minutes try this out. An exercise to increase your knowledge and improve the odds of achieving your goals? Homo economicus would approve.
This is a journaling exercise. Get your writing instrument ready, and ask yourself the following questions:
1. What are your greatest financial fears?
2. Assuming that your greatest financial fears are realized, what is the worst thing you can picture happening?
-What would you lose?
-How would it impact your living situation?
-How would it impact the people you love most?
-How would it impact your self-concept?
-How would it impact your emotions?
-How would it impact your quality of life?
-How would it impact your goals?
3. Prepare to accept these most dire consequences as if you have no choice.
-What would you do?
-Where would you live?
-How would you get your needs met?
-How could you handle it cognitively (e.g. what would you say to yourself?)
-How could you handle it emotionally (e.g. how would you cope with or manage your feelings)?
4. Now that you have accepted the worst consequences, what could you do to improve on the worst of these outcomes?
-What could you do to improve your situation?
-Assuming you made progress on improving, where would you see yourself in 5 years?
In 10 years?
-What might you have learned from this experience? How might it have helped you?
©Copyright 2016 Dr. Brad Klontz and Dr. Ted Klontz