Buyology: Stress and financial decisions

Jul 27, 2021

Dr. Amos Nadler, Ph.D. Chief Economist at Fabriik

We always make decisions like fully rational, benefit-maximizing robots, right? Not so much. More like the opposite of cool, calm, and calculated — we make quick, rule-of-thumb driven, impulsive, and intuitive decisions more often than we’d like to admit. What makes it even harder to make good financial decisions? Stress. It’s right at the top of the list. And given the challenges posed by a less decipherable stock market, crypto uncertainty, a more polarized republic, evolving pandemic, and disconcerting draught, stress is higher than usual for most of us right now.

Financial bio-behavioral research shows us that short-term stress hormones push us to rely more on intuition than logical, linear thinking, but interestingly, it doesn’t seem to affect our risk preferences. Longer-term stress though can make us less willing to take risks, which makes sense, for when facing chronic challenges a person would tilt towards being more conservative to avoid falling into irrecoverable losses.

A three-step process to decision making under stress

People and markets can over-or under-react to the news by being unable to accurately interpret financial news, which means that those with composure can capitalize on the chaos. Also, markets can be irrational in the medium term due to excessive pessimism from chronic stress and uncertainty — central banks fear this, which is why they buoy asset-buying with easy money policies. Given the multitude of challenges we’re facing, it is vital that we learn the effects of stress on decision making. A three-step process can help guide us when under stress and can keep us from making costly mistakes.

  1. Recognizing that people and the markets they move are subject to biological forces. This insight empowers you to make decisions that account for the influence of stress and others who do not account for it are more likely to act irrationally.
  2. Seek input from others who have a different perspective to cross-check the reality of your assumptions and test your logic.
  3. Think through scenarios while incorporating outside input and make decisions based on deliberate thinking rather than quick, biased, and impulsive thinking that is likely more prominent due to being under greater stress.

If you’re interested in discussing this article and/or the research behind it, please feel free to hit me up on Twitter.

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