Recognize Behavioral Signs before Your Emotions Take over in Making Strategic Financial DecisionsChia-Li Chien, Ph.D., CFP®, PMP®, CPBC
Chia-Li Chien, CFP®, PMP® Oct 15, 2016
A number of years ago, Betty (not her real name) went into cardiac arrest and John, her husband (not his real name) had the ambulances take her to the nearest hospital emergency room. While restlessly waiting for the emergency staff’s help, the surgeon on call asked John about what resources they should use to save Betty. John was given three options:
Option 1: The resources used will be covered 30% by medical insurance, but they are the best and most reliable ones.
Option 2, The resources used will be covered 50% by medical insurance. In addition, the resources are better than the default option, but might lead to complications for Betty.
Option 3, The resources used will be covered 100% by medical insurance. They are, however, the default option and historically lead to complications in the recovery process.
In the heat of the moment, John had to make a strategic financial decision to save Betty. Emotion kicked in, and the logic of the couple’s financial status never crossed his mind. He went with option 1.
According to Mangan (2013), a study conducted by NerdWallet Health Analysis found that the largest age group of Americans filing for bankruptcies was ages 35 to 44, followed by ages 45 to 54. LaCapria (2016) clarified that 60% of those filings from the same study were medical-related.
In John’s situation, several academically defined, adverse financial behaviors are exhibited, including: framing, default options, placebo effects, loss aversion, etc. John’s decision would cost him if he did not recognize these financial behaviors.
Shiller (2012) identified a few of the financial behaviors, such as: the classical Prospect Theory developed by Nobel Prize-winning economists Daniel Kahneman and Amos Tversky. People make decisions about their prospects by gambling because they operate with uncertainty. John making the medical decision regarding resources for Betty is an example of that. He gambled to save Betty’s life under high uncertainty—choosing between the potential death of Betty and the risk of enormous healthcare costs.
Other adverse financial behaviors Shiller (2012) identified are Default Option, Framing, Regret Theory, and Anchoring. In John’s case, the surgeon framed Betty’s situation as a question of how the resources used could save Betty’s life. The surgeon also invoked a default option and anchored the decision with Option 1, leading John toward the choice of that option. Remember, the hospital has to make a profit or at least break even in providing patients with service. Option 1 creates the highest potential profit margin for the hospital.
Some of these academically defined financial behaviors, by contrast, can help you make good decisions, though some are used to manipulate consumers. Take, for example, the 401(k) you signed up for at work. When you first signed up, what were some of the default options you saw? Opt-in? It was designed for you to save; hence, Opt-In to save is a default. Then, an employer match up to 6% of your contribution functions to anchor how much you should save. Both of these features were carefully designed by your employer with the help of financial institutions to help you save.
However, Herd Behavior or Social Contagion made people buy houses that they couldn’t afford during the height of the housing market bubble. This resulted in underwater housing values and large amounts of mortgage debt to cope with. Many of these folks were victimized by herd behaviors; they simply followed the herd without recognizing the nature of their responses.
So what can you do in the face of all this? If you’re confused about any decision, do nothing. Take a moment to think by prompting your body to cool down. Helpful activities might include walking outside for a moment, or asking for few minutes to think about the problem. Let your logic help you make the right decision when you are not in the “heat” of the moment. When in doubt, just do nothing. And remember, when your hairdresser speculates that XYZ is the hottest investment she’s ever made, that is a warning sign to walk away and prevent your emotions from leading to a harmful financial decision.
Shiller, R. (2012). Behavioral Finance and the Role of Psychology. YaleCourses. Retrieved From June 14 ,2016 https://www.youtube.com/watch?v=chSHqogx2CI
Mangan, D. (2013). Medical Bills Are the Biggest Cause of US Bankruptcies: Study. CNBC. Retrieved From June 14 ,2016 http://www.cnbc.com/id/100840148
LaCapria, K. (2016). Money, Cash, Throes. Retrieved From June 14 ,2016 http://www.snopes.com/643000-bankruptcies-in-the-u-s-every-year-due-to-medical-bills/