How Emotions Affect Our Financial Decisions (Part 1)

In December 2016, the popular Ponzi scheme known as MMM reached the limit of its operations and inevitably crashed, causing the loss of millions in personal finances, failure of numerous businesses and even multiple suicides. The aftermath of MMM’s closure was quite devastating on Nigerians, so we decided to study the underlying reasons why MMM was able to work so well.

We found that it came down to two key elements: Low financial literacy and most especially, Financial desperation in Nigeria. Amid a severely weakened naira, fast rising inflation levels and an economic recession, the demand for alternative sources of income was extremely high. MMM presented itself as the “get rich quick scheme to put an end your financial troubles”, leading to numerous Nigerians investing their money with hopes of capitalizing on MMM’s unsustainably high 30% ROI (Return on Investment).

 

A fully rational mind, free from constant thoughts of how to make ends meet, would’ve been more cautious of this glittering prospect; after all, if something looks too good to be true, it probably is. However, the air of desperation highly influenced the decision making of over 2 million Nigerians, even in the face of very evident risks.

The financial decisions we make are heavily connected to the various emotions we feel from time to time, the best we can do is prevent these emotions from steering us in the wrong direction. In response to this, we will be doing a two-part series on how emotions affect our financial decisions; and in this article, we will be highlighting how four common emotions affect our financial decisions then discussing the various ways to prevent these emotions from leading us astray:

 

1. Anger

Anger is a very powerful emotion which causes us to make impulsive financial decisions in the heat of the moment, even the great Warren Buffet fell prey to this emotion. In 1962, Warren Buffet and Seabury Stanton, the CEO of Berkshire Hathaway at the time, had a gentleman’s agreement on an offer price at which Berkshire shares would be repurchased from Buffet. However, when Buffet received the offer, he noticed that the CEO’s offer price was lower than they had previously agreed. Buffet took this as a personal insult and bought a controlling share in the company just so he could have the pleasure of firing the CEO.

Although this might have given Buffet satisfaction at the time, he ended up wasting precious time and resources reforming a company that was in terminal decline, instead of allocating his funds into more profitable ventures; Mr. Buffet himself labeled this - The worst investment he ever made. Anger causes us to make impulsive financial decisions, by making us blind to the downside of our actions in the heat of the moment.

 

How to reframe it

What is required to prevent angry financial decisions is an objective third party, in the form of a financial adviser or a friend, that can give you the distance you need to put aside your anger and make more rational choices.

I would also advise that, as much as possible, we refrain from making important financial decisions in the heat of the moment. Taking a step back and a few deep breaths to clear your mind off anger will help you minimize impulsive decisions that you will most likely regret in the future.

 

2. Anxiety

Anxiety stems from a place of fearful uncertainty, usually characterized by a sense of worry and general unease when thinking about an uncertain outcome. How anxiety affects our financial decisions depends on what the underlying cause of anxiety is i.e. what exactly we’re fearful of.

For instance, if you’re anxious about financial security (which a lot of people are), you are more likely to exaggerate risks when making financial decisions for fear of making a mistake and losing money. I remember in 2011, a course mate of mine offered to sell me bitcoin because he needed some cash. At the time, one bitcoin was worth $30 (₦10,920), up from $1 a year before, so it definitely showed some promise. But despite the fact that I saw potential benefits from investing in bitcoin, I was anxious about its dramatic price swings and long-term safety as an investment, so I opted out of the deal. Today, bitcoin is worth $2886 (₦1,050,500), about 96 times what is was worth when I was offered. *Sigh*

 

How to Reframe It

The problem when dealing with anxiety is that it’s quite difficult to “think” your way to a solution; anxiety will have you endlessly playing out different worst-case scenarios in your head. You can only minimize anxiety’s influence on your financial decisions when the whirlwind of thoughts is minimized and controlled. Here are a few steps to help you do just that:

  • Separate Fact and Fiction

An important first step to curtailing anxiety is sorting out your thoughts by separating what is a fact from fiction. For instance, your office has announced that it will be downsizing (Fact). You think you will be fired and never be able to find another job and end up losing your family (Fiction). Although this sorting process is easier said than done, making this separation is an important starting point.

 

  • Devise helpful plans

After identifying the Facts and Fiction, the next step is to use the Facts to devise concrete plans that will ease your anxiety. For instance, in the job layoff example used above, you could use facts like your current financial standing (how much you have saved and any debt you have) to develop a financial plan that will boost your emergency fund and ease the blow in the unfortunate event that you do lose your job.

 

Related: How to get a grip on your savings

 

  • Speak to an advisor

It is advisable to speak to an experienced guide, like a financial advisor or knowledgeable trusted friend, who can help you develop your plans and whom you can discuss your financial fears with. Getting an outside perspective on the things you’re anxious about will help you minimize fearful thinking and objectively weigh up the risks and rewards of each financial decision you have to make. For instance, I could be benefitting from bitcoin’s tremendous growth today if I had spoken to a cryptocurrency advisor to weigh up the pros and cons of the bitcoin investment.

 

  • Work with your body

Bodily activities such as regular exercise and conscious breathing can significantly help you control anxious thinking. Practicing conscious breathing by taking 5 deep breaths-in through your nose and out through your mouth will slow your heart rate, calm your mind and help you reduce anxiety.

 

3. Excitement

The ever-present feeling of stress in Nigeria has left its citizens yearning for something, anything, to celebrate and be excited about. The cause of excitement could be anything ranging from a wedding to the purchase of a new car/house; in fact, there are very few places in the world where Friday, the end of the work week, is celebrated more vigorously than Lagos state, Nigeria. However, excitement could have seriously harmful effects on our finances and I’ll explain how with a story:

Last Christmas, Freddie - one of our very own co-founders, was excited about his first self-financed trip to Nigeria. He was hellbent on absorbing as much of Nigeria as he could during his 3-week holiday and set a £500 (₦236,000) budget to do just that. When he arrived in Lagos, he went everywhere; from seminars and meetings on the Mainland to parties and the Migos concert on the Island. It was a well-rounded visit.

When he returned to England and was able to settle down with his bank statement, he found out that he gone over his budget by £500, far more than he anticipated or previously planned for. You see excitement tends to make us spend more money than we would under normal circumstances. Although there’s really nothing wrong with spending money to celebrate, it’s important that we don’t get carried away with our spending, or we could end up regretting our decisions later on when we’re sober and financially depleted.

 

How to reframe it

If you want to minimize bad financial decisions when you’re excited, what you need is a spending limit to prevent you from going overboard. Your spending limit should be an amount that you can afford and not regret that you spent at a future date. Having a financial limit in mind serves as a reference point every time you consider spending money.

You can also take the spending limit strategy to another level by creating a separate account, which is what Freddie did. Freddie took two key steps to ensure that he never overspent due to excitement again:

  • He opened a separate account called “rocks account”, which contains ALL the money he’s allowed to spend for any particular cause of excitement (like a trip or a party). This account acts as a great way to limit overspending because once money in that account is finished, excitement spending is over.

 

  • He also designed a strict personal budget and uses it to do a monthly financial review which ensures that he’s on top of his finances at all times.

 

Related: How to design a personal budget

 

4. Jealousy

So, a friend of yours just put a down payment on a house while you're still living with your parents and you’re feeling a little…jealous. According to Amy Jo Lauber, president of Lauber Financial Planning, this is a perfectly normal reaction. "Humans are social creatures in a constant state of comparison" she says. 

However, it is important that we don’t become obsessed with keeping up appearances and overly concerned with what others are doing, which are two prevalent problems in Nigeria’s society today. If you’re unable to curb jealously, it’s very likely that you’ll continuously spend above your means and end up in some form of debt as a result.

 

How to reframe it

Turn your jealousy into an opportunity for growth by using it to instigate a period of self-examination about your finances. Drake once said “Jealousy is just love and hate at the same time” – you love what the person has, but you hate that you’re not the one that has it. So, during your self-examination, think:

“What is one thing that I really want and I don't have?”

"What is missing in my life right now?"

Is it a vacation?

A new car?

The key is to let your jealousy fuel your desire to work harder and make smarter money decisions—like forgoing expensive meals out a few nights a week or saving the money you spend on premium TV channels you never actually watch—for you to be able to afford the things you covet.

 

Well, this concludes the first part of our two-part series on how emotions affect our financial decisions; and we really hope you found this article helpful. Please comment below or send us a message to let us what emotions you’d like us to discuss in part two, we would really like to hear your thoughts. As always thanks for reading and till next time, stay on top of your daily kobo.

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