The reciprocal relationship that affects our financial decisions and mistakes.
From winning the lottery to the global financial crisis; our psychology is intimately linked with our finances. Financial worries accounted for three of the four greatest concerns in 2021, only outranked by COVID-191. Specific professions like financial psychiatrists have been created to address these concerns. Money can influence our perception and choices. Conversely our personality can affect our finances. Here are some common ways this can happen.
The sunk cost fallacy is the human tendency to let our previous investments and losses (sunk costs) influence our future decisions2. This typically refers to economics however it happens in politics, business and relationships. For example, the longer people spend in a relationship the more likely they are to stay because of the time they have invested. Similarly, if someone invests in a company, then the stock dives, they may double down on their investment in a desire to recoup the money they have lost. However, the previous loss does not necessarily predict the next outcome. When people make financial decisions, they’re often based on emotions not logic.
Another recent psychological phenomenon is Sudden Wealth Syndrome. The term was coined by psychologist Stephen Goldbart to describe the distress people experienced after suddenly making large amounts of money3. Typically, this happens to people who have made money through winning the lottery, inheritance, and even crypto currency. This sudden change in circumstances can affect their self-image, motivation, and relationships. It can be exacerbated if they put little to no effort into making that money, like buying a lottery ticket. Although it may be hard to empathise with the struggles of someone gaining incredible wealth, the symptoms can be severe. People often begin to disconnect from their friends and family as they start to distrust people’s motives. They also might fear losing their wealth, could become paralysed with new choices or worried about the impact on their children4. This doesn’t mean that having more money is a terrible thing, but it can be complicated.
A personality trait that can affect the financial decisions we make is Extroversion. In her seminal book Quiet: The power of Introverts, Susan Cain suggests listening to Introverts could have reduced the severity of the Global Financial Crisis of 2007. In fact Cain provides multiple examples where Financial Institutions ignored and even demoted introverted employees, when they raised concerns. Many companies chose to promote and listen to extroverts preferring their positivity, high energy and confidence. Unfortunately, extroverts are also more likely to discount the potential risks when deciding. They are also more likely to have a sensitivity to rewards, which can drive them to make unreasonable decisions. Warren Buffet even suggests that people who are highly reward sensitive and unable to endure the natural highs and lows, shouldn’t be in the stock-market.
The relationship between psychology and money can affect global, local and personal decisions. With the cost of living rising in many countries around the world, you might be more likely to make an emotional financial decision. It might be time to look at your financial plans from a different angle. You could run your plans by a friend or a financial advisor. If you think your emotions might be getting the better of you, you can speak to a psychologist or counsellor for more support.
National Debt Helpline 1800 007 007. (9:30am to 4:30pm Monday to Friday)
By Will Sutherland
1. Gebrekal, T. (2021). What Worries the World? August 2021 [Review of What Worries the World? August 2021]. Innovation & Knowledge : Society. https://www.ipsos.com/sites/default/files/ct/publication/documents/2021-08/What%20Worries%20the%20World-August_2021.pdf
2. Thaler, R. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior & Organization, 1(1), 39-60. https://doi.org/10.1016/0167-2681(80)90051-7
3. Blog | MMC Institute. (2010). Retrieved June 27, 2022, from http://www.mmcinstitute.com/about-2/sudden-wealth-syndrome/
4. Wealth Psychologist. (2019). Investopedia. https://www.investopedia.com/terms/w/wealthpsychologist.asp
5. Cain, S. (2013). Quiet : the power of introverts in a world that can’t stop talking. Penguin Books.