The Financial Psychology Behind Big Life Decisions: How Emotions Influence Your Money Moves

Making wise financial decisions isn’t always simple. At the surface level, an opportunity or adjustment may seem like the best move for your current situation, but emotions distort our judgment more often than we’d like to admit. This is because we rarely view money as cold hard cash; whether we want to or not, we all experience strong emotional responses and biases regarding our finances. Emotional bias in finance, often referred to as behavioral finance, is a well-documented topic. A study by Nobel Prize Winner Daniel Kahneman found that we make financial decisions based on emotion rather than logic 90% of the time.

Most big life decisions involve money in some way or another, making it difficult to distinguish between wise financial choices and emotionally driven responses. Knowing how to manage your money wisely starts by acknowledging the intersection of psychology and financial decision-making.

The Impact of Emotionally-Led Financial Decisions

To better understand how easily emotions can steer financial decisions, let’s look at some hypothetical scenarios.

Example 1: Buying a Home

Two couples are each planning to buy a home. Interest rates are high, but Couple A is confident that they’ll drop significantly in the next few years. They take out a mortgage for their dream home with payments that are higher than they’re comfortable with, arguing that the decision will be worthwhile as soon as the rates drop and they refinance. Except the rates don’t drop right away, and the high mortgage payment begins to erode their savings and put a strain on their relationship. Meanwhile, Couple B decides to hold out and wait for interest rates to drop before purchasing a home. They wait and wait, but rates continue to rise instead of level out, eventually pricing them out of the type of home they hoped to buy. Rather than making an informed decision based on the facts, overconfidence, and fear put each couple at a financial disadvantage.

Example 2: Managing Retirement Income

A hardworking business owner has finally crossed the threshold into retirement and a well-deserved life of leisure. He’s worried about the possibility of inflation or medical expenses eroding his retirement savings, so he lives as frugally as he can. He doesn’t run out of savings, but his retirement begins to slip by without him doing any of the things he hoped to do. By letting fear rather than facts dictate his budget, his golden years are filled with anxiety instead of the family vacations and hobbies he worked toward.

Example 3: Receiving a Windfall

A woman’s wealthy relative passes away, leaving her a sizeable and unexpected inheritance. Elated, she can’t wait to share her good fortune with friends and family and buy a few nice things for herself. But living generously and making rash financial decisions depletes her inheritance much more quickly than she anticipated. She got too caught up in the excitement of a windfall and missed a once-in-a-lifetime opportunity to make significant progress toward her financial goals.

Overcoming Emotions to Make Wise Financial Decisions

While each of these scenarios is purely hypothetical, the negative impacts of letting your emotions guide your financial decisions are very real. When you’re facing big life decisions and are unsure if you’re choosing the right path, here are three steps we recommend taking.

1. Have a plan. Work with a financial advisor to create a comprehensive financial strategy that outlines your goals, identifies your values, and considers your risk tolerance and unique circumstances. By collaborating with a trusted financial planner, you’ll have an objective framework for your finances to refer to when emotions are heightened.
2. Get the facts. Many emotions thrive in the dark, especially fear and anxiety. When headlines or unexpected circumstances cause you to worry, talking to a trusted professional can shed light on your situation. An advisor who upholds their fiduciary duty and aligns their guidance with your financial strategy can help you determine the best course of action.
3. When in doubt, pause. Ask yourself, “Does this help get me where I want to go? Does it align with my core values?” Filtering decisions through the lens of your financial plan will help ensure your long-term goals are the focus, not the circumstances.

At HFG Wealth Management, we understand that financial planning is deeply personal and inextricably tied to emotions. We help you keep the things that matter front and center and take a truly holistic approach to wealth management so that your financial strategy is guided by your goals, values, and legacy. If you’re searching for reassuring guidance backed by years of experience, we’d love to help you navigate the milestones in your life with confidence. Connect with us today to start your journey.

HFG Wealth Management, LLC

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