How Emotional Decisions Can Get You Off Track

How Emotional Decisions Can Get You Off Track

January 10, 2024

*This post highlights Chapter 1 from Mike’s book, Achieving Financial Fulfillment.

It is estimated that we make about 35,000 decisions every day. Many of these may seem trivial, but almost all of our decisions are linked to our emotions.  So, of all the decisions you will make today, how many of those do you think will be financial ones?  In order to make smart financial choices (instead of emotional choices), we need to be aware of how we make choices, how our emotions play a role, and ultimately how emotional decisions can impact our financial lives.  

When it comes to financial planning, the most common emotional mistakes occur in managing investments, due to common emotional biases. Below are two common biases (emotions) that can impact our thoughts and decisions.

Herding Bias    

The practice of herding livestock has taken place for centuries.  Some animals form herds on their own as a form of protection against predators and to move together to the most fertile grasslands.  But is herding a good practice for investors?  The fear of missing out (or FOMO) is a real human behavior.  People follow the actions of others they believe have done their research, but many are followers themselves! 

Real-Life Example - The tech or ‘dot-com’ bubble of the late 1990s was perhaps one of the best examples of an investment trend based on herding.  People with little or no experience bought technology stocks that seemed to be continuously rising in price because other people said they were “making a ton of money.”  Many of those companies had no significant earnings record or sustainable profits and fell apart or went out of business once the economy eventually slowed down.  The panicked buying created by FOMO was later followed by panicked selling as people tried to preserve some of their remaining gains and limit losses.  The tech-heavy Nasdaq market lost more than 75% of its value in 2000 and did not return to its prior peak value until 2015.

Confirmation Bias

When was the last time you did a Google search and scrolled past the first few results to find what you were looking for?  If you haven’t noticed yourself doing this before, you will now.  It is a natural human tendency to seek information that we want to find in order to confirm our existing beliefs.  Unfortunately, this type of bias can prevent us from looking at situations objectively.  It can also influence the decisions we make and lead to poor or faulty choices.

Real-Life Example - Evaluating individual stocks can provide a good example of confirmation bias.  Maybe you see a product or hear about a new company whose technology seems to make sense.  In your mind this could be something that many people will need or appreciate, so you start to investigate it further.  Now you may start seeing a need for this product everywhere as you evaluate the prospects of the company’s growth.  Are you reading the articles that highlight the product’s competitors?  My guess is no.  As Warren Buffet once said, “What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact.”  You may also be more likely to trade investments more actively when your beliefs are confirmed by others because it leads to a sense of overconfidence.  However, it may also cause you to expect higher returns on investments than what may be justified.  The bottom line is that we need to seek out facts to limit the impact of confirmation bias on our decisions.

There are other emotions that can impact our ability to make sound financial decisions including regret and fear.  As human beings we are not necessarily programmed to be good investors.  We can get excited and overconfident in our own decisions when things are going well and want to run and hide when markets fall.   My opinion may be biased, but this makes a pretty strong argument for seeking professional advice when it comes to navigating the world of personal finances and the many decisions involved.  An independent and unbiased advisor should be less likely to be subject to the emotional ups and downs as you may be with your own money.