Three Steps to Improve your Financial Decision Making

Here are three simple steps for managing your reaction and financial decision-making during these times of turmoil.
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By Dennis Stearns, CFP®

Remember the “This is your brain on drugs” commercial in the late 1980s? The picture we got was of a fried egg sizzling. Could it be that our brains are experiencing something similar today – but not due to drugs? There is so much harmful stimulus right now.

Dennis Stearns

Dennis Stearns, CFP®

Many people are being hit with multiple sets of anxiety-producing information: First there was COVID-19 and all the health concerns and anxiety for self and loved ones. Then the uncertainties regarding their investments and the economy. Perhaps there were also fears about their livelihoods or their children’s jobs. Layer in all the social unrest and concerns about whether our current or future leaders will make the right calls to stabilize the roller coaster in the post-COVID world, and, well, the mental image of a fried egg sizzling certainly does come to mind.

We don’t know how many Americans, and people all over the planet, are having bouts of anxiety or depression as a result of all this. Anecdotal evidence suggests it is a very, very high number. The constant potential for danger sets off inevitable reactions in our bodies. When we feel threatened, our nervous system responds by releasing a flood of stress hormones, including adrenaline and cortisol, which signal it’s time for emergency action. Our hearts pound faster, muscles tighten, blood pressure rises, breath quickens, and our senses become sharper. These physical changes increase strength and stamina, speed up reaction times, and enhance focus—preparing us to either fight or flee from the danger at hand.

Turns out our nervous system isn’t very good at distinguishing between emotional and physical threats. Even though the COVID-19 mortality rate is “only” around 1% (albeit higher for older adults and those with compromised immune systems), our bodies react just as strongly as if we’re face-to-face with a saber tooth tiger, where our odds, thousands of years ago were less than 50-50 to escape alive. Neurologists who have studied “fight or flight” reactions say the more one’s emergency stress system is activated, the more our bodies release chemicals to cope with the threat.

So that’s the first jolt to our body’s ability to feel normal and cope with unexpected events. Now let’s layer on how our brains respond to different investment situations. Neuroeconomics is the study of how we make decisions using brain activity (neuroscience), economics and psychology. One of the best books to explain these issues in layman’s terms is Jason Zweig’s classic, Your Money and Your Brain.

According to Zweig, the brain of a cocaine addict who is expecting to get a fix and people who are expecting to make a profitable financial gamble are virtually the same. This explains why we tend to get overconfident and/or greedy with our investments.

But what about simply getting through the pandemic with our life savings largely intact? Unfortunately, getting exactly what we planned for is basically a non-event for brain activity. Seeing the fruits of our labor to save money, or survive the pandemic, should be satisfying. Turns out our brains need a bigger hit of adrenaline or dopamine to get a bigger fix every time for the same emotional response. Perhaps that explains why “pandemic anxiety” is causing many to make extreme decisions they might not make in other circumstances. This includes our investments.

Financial losses, or the fear of loss, are processed in the same area of the brain that responds to mortal danger. For most people, losses hurt much more than gains feel good. Loss aversion can be a huge problem for our long-term financial health if we let the mortal danger signal take over during a panic in the markets. Or a perceived fear of another wave of infections. Or a leader getting elected who won’t make the right calls in an uncertain future.

Zweig’s research also shows the anticipation of a gain creates a much larger response than actually receiving the gain. In other words, getting through the pandemic to something resembling “normal times” may not create the happiness we crave. And we know that money doesn’t buy happiness. People spend plenty of time planning to buy something expensive and feel the rush in anticipation of that purchase only to feel let down once they actually buy it. Retail therapy is fleeting.

Zweig also provides this wise counsel: “The best investors make a habit of putting procedures in place, in advance, that help inhibit the hot reactions of the emotional brain.”

Here are some thoughts on how to keep grounded – no matter what unexpected “saber tooth tigers” we experience going forward into 2021. These three simple things will help limit mistakes that may be made by the hot reactions of the “emotional brain on anxiety-producing change.”

1. Know the financial plan projections in various future scenarios

Unfortunately, less than 3% of Americans have a written financial plan. A multi-scenario plan can provide a “core and explore” approach to personal money management. How much belongs in each bucket depends on one’s ability to deal with the fight or flight issues and the behavioral finance traps outlined in Zweig’s book. It also depends on the assets and liabilities compared to income sources, longevity and future expenses.

The “core” is the amount one needs for the future to avoid feeling crushed if events go worse than expected next year or beyond. It’s a good idea to keep the core relatively safe, without sitting on cash and bonds so long that resignation sets in and the portfolio begins losing ground to inflation over time, potentially impacting a good “return on life.” Ironically, longevity numbers are getting ready to upwardly explode, post-COVID.

The “explore” is how much an investor can afford to invest for growth just in case the individual or their spouse live longer than expected. This is critical considering the dramatic revolution in health care that is likely in the next ten years, which has been turbocharged by the pandemic.

The “explore” portion of the portfolio could be focused on conservative growth; for example, blue-chip quality stocks with good ten year prospects. It could be investments that lean into the techno-industrial revolution – blue-chips like Microsoft, or FutureTech like robotics and genomics. It could be alternative investments that don’t zig and zag with the stock market. For most people, a blend of these is the right answer.

2. Recognize and accept limitations

Our brains automatically and unconsciously expect a 3rd repetition after we see two in a row of something. This is a very dangerous brain reality given all the unexpected change we are being hit with today. There were studies in Your Money & Your Brain that looked at the response of subjects trying to make predictions about unpredictable events. Even though the subjects were told ahead of time that what they were looking at was unpredictable, they still thought that they could do it, even if everyone else would fail. Most drivers think they are “above average” – laughable if we think about it – but this is not laughable when it comes to the hard work it typically takes to realize financial independence.

Have someone who is well-grounded help with rationally considering future scenarios. It could be Uncle Ed who has good common sense. It could be a best friend. It could be a trusted advisor. We must tone down and manage our own reactions to unexpected events. When sailing in today’s uncharted waters, an informal advisory board of people with an uncommon level of common sense is a good idea.

3. Limit the consumption of hazardous materials

Don’t watch too much cable TV or read sensational doom-and-gloom internet stories. We all know what calms us down – if it’s taking a walk, do more. If its chocolate, well, do more of that, but in moderation, of course.

Finally, consider this: In 1957, the average American earned about $10,000 (adjusted for inflation) and lived without a dishwasher, clothes dryer, TV, or air conditioner. But 35% of people surveyed then said they were “very happy” with their lives. Today, personal income had skyrocketed pre-pandemic but happiness surveys showed less people happy with their circumstances. It comes down to our perspective.

What will make you happiest in the post-COVID world?

Most people think they need more of everything (money, material possessions, etc.) to be happy, yet most find that rewarding experiences and spending time with family and friends is what makes them the happiest.

About the author: Dennis Stearns, CFP®

Dennis Stearns, CFP®, is a frequent contributor to Retirement Daily and has been called “one of the leading scenario experts and futurists in the financial planning industry” by the Financial Planning Association. Stearns is the author of several books, including Fourth Quarter Fumbles: How Successful People Avoid Critical Mistakes Later in Life. He is a chess expert and played on one of the winningest chess teams in Pan-American history. More information, including a free Fumbleocity quiz, is available at www.StearnsFinancial.com .