Balancing logic and emotion in financial decision-making

Last updated on 28th March, 2024 at 03:15 pm

This is how to balance the brain versus the heart when it comes to financial decision-making and avoiding emotional spending.

Estimated reading time: 3 minutes

In this article, you’ll learn:

• We make most of our financial decisions based on our emotions
• Certain emotions can make us more prone to unnecessary spending
• Tips to avoid making financial decisions based on emotion

Daniel Kahneman – a Nobel Prize-winning psychologist and expert in behavioural economics – came up with a theory. It’s called the Prospect Theory, and he won the Nobel Memorial Prize in Economic Sciences for the research in 2022. It suggests that we make financial decisions based 90% on our emotions and just 10% using logic. While this can sometimes aid us in making smart choices, it can just as often, if you are triggered, lead to poor judgement and unnecessary and unwise emotional spending.

What do money triggers look like? These can be anything from:

• Sadness (spending money to cheer yourself up)
• Boredom (splashing your cash to pass the time)
• Stress (buying things you hope will make life easier)
• Jealousy (splurging to keep up with your peers)

Sensible spending

Curbing impulse spending isn’t as simple as avoiding your triggers because we can’t hide from our emotions! What we can do, however, is realise that we have a choice in how we react to the signals our brains send to us.

Linda Remke, founder and Master Life Coach at EVEOLVE says that we should rely not on our fleeting emotions but on our core values when it comes to determining which expenses are important and which are not. “Your values influence your long-term financial goals and priorities,” she explains. “For example, if you value financial security and independence, you may prioritise saving for retirement or building an emergency fund over discretionary spending. If you value experiences and personal growth, you may prioritise spending on travel, education, or hobbies over material possessions.”

By identifying what matters most to us, we can make better choices and be less swayed by our mood when it comes to spending money because our values serve as a compass for navigating life decisions, both personally and in business. When you fear you are about to swipe for something new and shiny, however, here are ways to react better to spending triggers.

1. Focus on the facts

Write down, think about or discuss with someone what you know regarding the situation that has triggered your desire to spend. As for what you want to buy, break down the numbers and see if it makes financial sense.

2. Consider your money scripts

This refers to all the tidbits and knowledge we picked up about finances throughout our lives. Recognise the ones that serve you well and try to actively unlearn the bad habits. Change starts with awareness, after all.

3. Enlist an expert

It can be helpful to have a third party in your life who can dissuade you from making impulsive, emotionally driven decisions and enable you to grow your wealth. They aren’t attached so have significantly more clarity.

It can be virtually impossible to not be influenced on how you spend your cash but, by keeping your overall financial priorities in mind, your purchases will automatically have more emotional significance. “If you have strong convictions about what matters most to you, you are less likely to succumb to external influences and make regretful purchases,” says Remke. She also reminds us that “understanding and aligning your spending with your values can pave the way toward increased satisfaction, fulfilment, and financial wellbeing”.