Emotional nuances can impact investments

New findings in the burgeoning field of Neuroeconomics confirm emotions play a huge role in how people invest.

But while advisors look for extreme highs and lows in clients’ lives, studies suggest more subtle everyday emotions can also impact investment decisions.

Researchers at Stanford University have found showing test subjects pictures of exciting images caused them to take risks, because those visuals stimulate action in the nucleus accumbens—an area of the brain associated with risk-taking.

On the flip side, images of scary things like spiders trigger the anterior insula, a part of the brain associated with seeking safety. In a controlled study, people who viewed stimulating images just before they made financial decisions were more likely to choose risky options.

Similarly, a Harvard University study found sadness can reverse the natural human tendency to value things they already own more than things they don’t. Exposing people to tear-jerker film clips for several minutes, however, caused test subjects to place lower value on their own assets.

These findings suggest seemingly trivial events, like what clients read in newspapers, or the conversations they have in the lead-up to a meeting, can influence investment behaviour.

What this means

Advisors should watch for extreme behaviour in their clients; anything out of the ordinary.

Whenever people are emotional, it’s a terrible time to make investment decisions because they’re liable to make decisions that are inconsistent with their long-term objectives. Understanding more subtle nuances in your client’s state of mind is just as important. While you might not care what he or she had for breakfast, a bit of small talk can help you learn about any small worries or excitements that could impact how a client views a portfolio.

People tend to say things like, “I couldn’t eat much because I’m worried about paying my kid’s tuition.” Comments like that are jumping-off points for deeper conversations about cash flow and debt.

You don’t need to become a psychologist. Simply being aware of alarming events in the newspaper, asking about a client’s morning commute, and gauging how the children are doing can provide emotional context for your meeting.

But be careful how you structure meetings. Placing too much emphasis on a small part of a client’s portfolio can alter the way he or she opts to move forward.

If you spend ten minutes focusing on the 2% of a portfolio that’s gone up 300%, the client may experience an emotional high that drives him to take more or too much risk.

Help your clients

You’re not likely to sit a client down to explain the principles of neuroeconomics. But you can help clients understand the role emotions play in financial decisions—and reinforce the idea that investing is a long-term commitment that requires sound decision-making. No decisions should be made in haste or on the basis of a temporary situation that will pass.

Also, be aware of your own state of mind. Before you start each day, ask yourself, “What am I feeling, and could it adversely affect my performance?”

Bad news; Bad choices

A 2004 Carnegie Mellon study warned tragedies like the 9/11 attacks can affect investment choices. People who react with sadness spend more and devalue what they already own, so the attacks may have encouraged some to spend. Scared people are more likely to take a conservative approach to financial considerations, while those who are disgusted may simply retreat altogether. Indeed, although there was a small dip in U.S. real personal consumption expenditures after 9/11, it rose steadily between 2002 and 2007.