Dose of Prose
As someone pursuing a career in Finance, it’s no surprise that I often have my mind on money and money on my mind. The conversations that I have about money with my peers, friends, family and even strangers are intriguing to me because every individual has their own unique experience and opinion on the concept of money and what it means to them. I hope that one day there will be more openness and transparency instead of stereotypes and stigmas surrounding the topics of finance and wealth, but until that day comes, my goal is for this blog post (among others I’ve written) to serve as the spark that ignites the flame of finance discussions.
The Psychology of Money
I was listening to a Wall Street Journal podcast that discussed the intersection of psychology and investing, which peaked my interest to write today’s post. Throughout my educational experience, it was emphasized to take the emotion out of business, and the WSJ podcast further confirmed that idea. I see even clearer why so many people assume that lawyers, bankers and other elites of corporate America don’t have souls, haha. Obviously this is a large assumption to make because not everyone in finance is a heartless a-hat who only cares about making a profit. However, the reason why it may seem that business people are emotionless is due to the significant impact that emotions have on decision making. When you put emotion into making decisions (whether business-related or not) it puts you in a vulnerable position of being reactive instead of proactive. I’ll address this more in the post, keep reading.
In today’s blog post, I want to share with you some insights and mindsets that may be helpful as you navigate investing or any other money making moves. The ability to have an emotional balance (not bias) approach in life is key, especially when building wealth. Here’s why:
The Endowment Effect
The endowment effect refers to the way in which individuals tend to prefer objects they already possess over those they do not. This type of behavior is usually triggered by two things:
- Ownership – items that have an emotional or symbolic significance to the individual.
- Loss Aversion – the tendency for people to stick with what they have and feel anxious to give things up.
Coffee Mug Example
For example, let’s say that I hang out with one of my friends and give them a coffee mug as a gift. A few hours later, imagine I hang out with a different friend and I don’t give her a gift at all (yikes). The following week, if I were to ask both of my friends to place a value on a coffee mug, then the friend who received the mug I gave them as a gift would place a higher value on it, than the friend who did not receive a mug at all. Why? Because you place a higher value on things that you own.
This tendency to overvalue things also occurs in investing and can have a significant impact on making investment decisions. What psychologists and economists have found is that when people invest in an asset, it becomes much harder for them to let go of it once they own it, because they place a considerably higher value on it than they would if they didn’t own it in the first place. Think about those times where you’re cleaning out your closet and you have trouble deciding whether something should stay or go. That, my friend, is the power of the endowment effect. You know you should throw that item away, but it’s difficult for you to do so because of its significance to you, or because the idea of getting rid of it feels like more of a loss or risk to you than just holding on to it.
Ask Questions, Build Wealth
Now that you know about the endowment effect and the impact it has on your decision making, how can you combat this? What should you do in order to transform emotional bias into emotional balance? Well, it all starts with your mindset. In order for you to prevent emotional bias, you have to recognize where it’s coming from. Check in with yourself and figure out how you feel. Whether you’re about to invest in a stock or if you’ve already made an investment, it might be helpful to ask yourself a few questions:
If I did not already own this stock, would I want to buy more of it at the current price?
If your answer to the above is no, meaning that you’re not willing to buy the stock if you didn’t own it, then ask yourself….
Why am I still holding on to this stock now that I do own it?
When answering these questions you may find that your emotional bias is causing you to hold on to an investment that is no longer making the return that you once thought it did. You may not want to believe or accept that this is the case, but based on your answers to the questions above, the reality may be that you let emotional bias get the best of you.
The bottom line here is: don’t let pride or ego get in the way of you making money. I’ve definitely been emotionally reactive in situations (I think we all have), but the important thing to remember is that we are all human and it’s natural to feel feelings. But I believe that asking yourself these questions and becoming more aware of your emotional biases can help you navigate investing, without allowing those emotions to reach the point of clouding your judgement.
We often talk about how exciting it is to find a new investment opportunity and getting in at the right time…but sometimes we fail to acknowledge the importance of knowing when to get out of that same investment we were initially so eager about. It takes a lot of courage to know when to let go of something, whether that’s walking away from an investment, friendship, relationship, etc. So I know that this whole concept of taking emotion out of decision making is easier said than done. As I always say…when you know better, you do better. And now you know that keeping these psychological biases in mind when it comes to investing can truly make a positive impact on your ability to build wealth.
