The Three Ways Stress Impacts Your Financial Decisions

Stanford researcher Robert Sapolsky’s thoughts on stress give some levity to what is a very real problem. “If you are a normal mammal, stress is the three minutes of screaming terror on the savanna after which it’s over with or you’re over with.”

Our stressors today are quite different from those of our agrarian and nomadic forebears, yet the cognitive hardware with which we process them remains largely unchanged. As a result, our physiological reaction to seeing a bear differs very little from the reaction to seeing a stock plummet, though the required responses are vastly different.

While fear of lion attacks may be obsolete, we are far from stress-free. The American Psychological Association’s 2011 report highlights this:

• 39% reported increased stress over the past year.
• 44% reported increased stress over the past five years.
• Only 27% reported decreased stress over the past five years.
• Only 17% reported decreased stress over the past year.

The significant sources of stress include money (75%), work (70%), the economy (67%), relationships (58%), family responsibilities (57%), family health problems (53%), personal health concerns (53%), job stability (49%), housing costs (49%), and personal safety (32%).

We feel less safe than ever, with money being our primary concern.

Stress impacts our investment decisions profoundly, leading to a hypothesized 13% reduction in intelligence during stressful times, as resources are redirected from the brain to support our fight-or-flight response. This also triggers a shift from rational, cognitive decision-making to an affective, emotion-driven style. Dr. Greg Davies, former Head of Behavioral Finance at Barclays, outlines three consequences of making decisions under stress:

1. Myopic Decisions: Under stress, we privilege the present and forget about the future, similar to choosing immediate gratification despite long-term consequences.
2. Reactive Decisions: Stress signals danger, leading us to react rather than reason, which is effective for immediate threats but detrimental for long-term investments.
3. Associative Decisions: Stress makes us irrationally link current events to past experiences, like drawing undue parallels between the Great Recession and the Great Depression.

Understanding these tendencies is crucial for managing stress and making better financial decisions. By recognizing how stress affects our judgment, we can take steps to mitigate its impact, such as developing a clear investment strategy and sticking to it, regardless of market turbulence. This approach helps ensure that our financial decisions are guided by reason and long-term goals, rather than by the immediate, emotion-driven responses that stress tends to provoke.

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