How stress affects your financial decisions

It’s a vicious cycle. The current economic situation has created an environment of stress as people worry about their finances and their jobs. Unfortunately, this stress can only lead to more financial woes because, as researchers report, stress can badly affect people’s judgment when making financial decisions. According to psychologists Anthony Porcelli and Mauricio Delgado of Rutgers University, “acute stress affects risk taking during financial decision making.”

The researchers conducted as test on a group of volunteers by asking them to make financial gambles in a stressed or stress-free environment. Stress was simulated by immersion of the participants’ hand in ice-cold water while room temperature water was used to simulate a no-stress environment. The choices were categorized as

• Risky, e.g. less likely but with a high payout
• Conservative, e.g. more likely but with a lower value

The results were consistent with a phenomenon known as the reflection effect – we tend to show increased conservatism when choosing between two potentially positive outcomes, but increase our risky behaviour when choosing between two gambles that result in a loss. However, this study suggests that stress exaggerates this effect; while exposed to stress volunteers were more conservative when choosing between potentially positive outcomes and were riskier when choosing between gambles that could result in a loss.

The researchers theorize that during stressful conditions, people tend to fall back on “automatic, lower-level thought processes,” and thus lose our ability to rationalize and think deliberately. The results of the study have some implication on those who work in the financial sector especially in stock trading where split second decisions are made that may mean a loss or a win of millions of dollars.

Previous studies on financial decision making have implicated the role of the hormones testosterone and cortisol. The level of the male hormone testosterone was positively linked to the amount of money gained by stock traders as well as their risk-taking behavior. The stress hormone cortisol, on the other hand, did not seem to correlate on losing or winning but reflected more the volatility of the financial market. In another study, researchers found that women who were given testosterone for a month did not exhibit increased risk-taking behaviour in making financial decisions. These findings may suggest that

• The previous link between testosterone and risky behaviour should be reevaluated.
• Women are simply more conservative by nature, and probably are “a safer pair of hands on the stock-market trading floor than men.”

Which goes back to the question as to how the global economy ended up in the mess we are currently in.

But back to stress – how can we minimize the effect of stress in our financial decision-making activities? Stay tuned for our next resource post on stress management.