With 1000s of people expected to make last-minute ISA investments this week, new research highlights the potential influence of emotion on financial decisions.
In an academic article in Psychological Science, Lerner, Li and Webber (2012) show that how you feel can influence how you make important financial decisions. They showed that different negative emotions such as sadness and disgust have very different effects. The researchers induced sadness by getting people to watch a sad film clip then write about a sad event in their life. They compared these sad individuals with others who had either been induced into a disgusted state, or simply left in their usual neutral emotional state.
The findings showed that sad people suffer from ‘present bias’, a stronger preference for immediate rather than delayed financial reward. Present bias is likely to disrupt important financial decisions taken by individuals who are sad after the death of a family member or after losing their jobs. The bias may lead them to use their funds for immediate consumption at the expense of more prudent investments that may serve their medium and long-term interests.
These findings have important implications for financial counselling of the bereaved or those recently made redundant: we may need to help these people take account of medium and long-term factors as well short-term ones when making important decisions.
The findings have important implications for fund managers and others responsible for investment decisions. They are likely to experience the full gamut of emotions as their fund rises and falls, yet remain unaware how these changes are likely to affect how they make their investment decisions. And with people’s financial choices at retirement blown wide open by the scrapping of compulsory annuities in the recent Budget, the issue of decision making will come into even sharper focus in the coming years.
One lesson that can be learned from these findings is to follow the old adage about sleeping on important decisions. The natural variations in emotional state that occur from night to morning is likely to induce different ways of thinking about the problem, thereby reducing the impact that a particular emotion based bias may have.
And, for once, it may well be the best option to leave the investment choice right up until Friday or Saturday this week, enjoying the emotional boost that often accompanies the weekend. TGIF may come to mean a good investment choice as well as an opportunity for that all important Friday night pint.