How Emotions Impact Your Financial Decisions

Finances are typically considered a matter of the mind, not the heart. Whether we're creating a budget, or picking a stock to invest in, we tend to see financial considerations as more logical and rational than other categories of decisions we make throughout the week. After all, most people agree we need to be smart when it comes to money—or else we will literally pay the price of ignorance.

Decisions about money are the perfect example of how practicing what one preaches can be extremely difficult. Emotions are a primary driver of decisions, in that we tend to feel positive or negative about something immediately—it's only later that we try to develop reasons or arguments to support this feeling.¹

The feeling-first model explains why it’s so difficult for us to walk away from a new pair of shoes we love at the store or say no to a night out with friends when these purchases are not in our budget. The planner in us knows it is the logically incorrect decision, but the feeler in us wants nothing more than to say yes.

Here are some of the biggest emotions driving your financial decisions, and how they work.

1. Fear

Fear is perhaps the most powerful emotion when it comes to shaping financial decisions. Research has found that the fear of losing $100 is significantly stronger in magnitude than the excitement of winning $100, a concept dubbed loss aversion.² Panic buying, which was on full display during COVID, is fundamentally driven by fear. All logic goes out the window, and fear leads people to buy all 20 bottles of hand sanitizer that Target has on the shelf.

The insurance industry is fundamentally fueled by fear. Insurance companies make money by, on average, changing customers more money in premiums than what the company must pay out in claims. However, we all happily purchase insurance to squash any fear of completely losing our home, car, or iPhone even though this insurance is a losing bet on average. Fear also manifests itself in business and investing—dissuading some people from starting their own businesses or investing money in the stock market, or leading them to pull money out of the stock market at the first sign of a downturn.

2. Greed

The emotion of greed can drive us to take on excessive risk in the pursuit of glamorous fortunes. Compared to other emotions, greed tends to be more rational or calculated.

Research finds that if you give people money and offer them the opportunity to share this money with someone or keep it, our spontaneous gut reaction is to be generous and share. However, if you allow people to think deeply about this decision, people tend to make greedier decisions.

While fear leads us to overestimate the odds of negative outcomes, greed can lead us to underestimate these odds. Greed promotes get-rich-quick thinking with money—leading to such behaviors as gambling, investing in cryptocurrency, and buying lottery tickets. (Some economists refer to the purchase of lottery tickets as a tax on the stupid—a fact I’m often scowled at for sharing with my friends). The emotion of greed can also lead people to overlook any downsides or risk, focusing only on the potential upsides—fantasizing about what it would feel like once you “hit it big”.

3. Anxiety and depression

Anxiety and depression operate differently than fear and greed. These emotions will often lead to what behavioral science calls “decision paralysis.”³

Because it often stems from instability in a relationship, a problem at work, or the negative results of another financial decision, experiencing anxiety and depression often leads to neglecting decision-making when it comes to personal finances. Putting off choices can be a positive thing at times—for example, it can help prevent impulse purchases. On the other hand, decision paralysis can have negative consequences such as waiting too long to start investing in a retirement account or neglecting to pay off debts with nasty accumulating interest rates.

How to Make Better Financial Decisions

Financial decisions, just like any other decision you make, can come from the head or the heart. Try asking yourself and others questions such as the following:

• Is this an emotional or logical decision?
• Are my emotions causing me to be too cautious and miss out on a good opportunity?
• Are my emotions causing me to be too excited and overlook the risks of a given opportunity?
• Is decision paralysis making an unpleasant situation even worse?

Fear Essential Reads

How to Overcome the Fear of Death

Torchlusspanik: The Fear of the Gate Closing

At a meta-level, understanding how emotions can impact financial choices is powerful. Next time you’re at a crossroads with a financial decision, ask yourself what role your emotions might be playing to help make the best choice possible.