Emotional Intelligence in Finance: How to Develop Financial Emotional Literacy

07.11.2023

What if I told you that your financial success directly depends on how well you understand your emotions?

Imagine that you are faced with a difficult financial decision. For example, the decision to buy a house on credit or wait a few years. Do you always choose the most rational path? Do fear, greed, hope, or other emotions influence you?

Scientific research shows that our emotions play a crucial role in financial decision-making. However, most people are not aware of this connection. As a result, we often make irrational financial decisions under the influence of emotions or even fatigue, leading to financial losses. Could this be the very knowledge that we all have been lacking?

The fear of losing money can prevent you from investing in a company’s stocks, despite positive financial indicators and growth prospects.

Greed can drive a person to take out a mortgage for the maximum amount possible to purchase more expensive property, even if it creates financial strain.

The hope for quick wealth can prompt individuals to invest all their savings in cryptocurrency or stocks without proper risk analysis.

The desire to prove one’s success can lead to excessive spending on expensive cars or gadgets, even if the person cannot afford it.

The desire for instant gratification can push one towards impulsive purchases of goods on credit instead of long-term spending planning. It may also simply be a desire to experience a positive emotion.

The development of financial emotional literacy—understanding one’s own emotions and the ability to control their influence—is key to more rational financial decision-making. This will help avoid common emotional mistakes and achieve long-term stable financial success.

In this article, I will explore the connection between emotions and finances, highlighting typical emotional mistakes and traps.


What is emotional intelligence in finance?

Emotional intelligence (EI) in finance is the ability to understand and effectively manage one’s own emotions in the context of financial decisions, as well as the ability to recognize and consider the emotions of others in the financial environment to achieve better outcomes. EI helps investors avoid emotional reactions to short-term market fluctuations while adhering to long-term strategies. In financial planning, EI promotes the setting of realistic goals and their achievement.

Next are typical emotional mistakes in finance.

1. Investment Management

A person with low emotional intelligence (or poorly developed) may demonstrate the following irrational behaviors:

Impulsive decisions. Without emotional control, a person may react to market fluctuations intuitively, making quick and unconsidered decisions about buying or selling assets.
Fear or panic. The lack of awareness and management of emotions can lead to fear or panic during market downturns and upswings, which may result in poor impulsive decisions.
Ignoring risk analysis. A person with low emotional intelligence may ignore or undervalue the risks of investment decisions, leading to unsuccessful strategies.

2. Financial planning

Procrastination in decision-making. An irrational person may postpone the development of a financial plan or ignore important aspects, hoping that problems will resolve themselves. This is a common issue.
Spending without thinking.

3. Interpersonal finances.

Lack of a shared strategy. An irrational person may act individually in managing interpersonal finances, disregarding their partner and not discussing financial decisions. This can lead to imbalances in both finances and relationships.
Financial conflicts. The lack of a shared rational approach, misunderstandings, or silence can lead to financial conflicts and ineffective management of the family budget.

Of course, all these actions can lead to financial losses. You might say, “No, I always try to be rational, analyze, and make the right decisions.” And you would be partly correct. But…

We can easily fall into the emotional traps of our thinking without even noticing.

Fear of losing money. This emotion often causes people to refrain from investing or pursuing business ideas due to the fear of loss. However, excessive caution can also cost money in the form of missed opportunities.

Greed The desire for quick profits drives many investors to buy stocks at inflated prices. As a result, they overpay and incur losses.

Heroization of success. The desire to emulate the success stories of famous millionaires leads to irrationally risky investments. People fail to consider the uniqueness of each situation and become captivated by their own fantasies.

Tendency to seek information that confirms one’s own opinion. This is the tendency to overweight or seek information that confirms existing beliefs or views. For example, if a person decides to invest in a certain sector, they may try to find only positive news about that sector, ignoring potential negative aspects.

Availability heuristic.




People often make decisions based on information that is readily available or comes to mind easily. For example, if several recent success stories in cryptocurrency investing have become known, a person may be inclined to invest in it, ignoring the risks. Following the well-known story involving pizza for Bitcoin, cryptocurrency gained even more popularity.

Illusion of control. People may experience an illusion of control over a situation, even when it is actually beyond their influence. For example, there may be a belief that personal knowledge or intuition allows for better management of investments than objective market analysis. Astrology, religious holidays, lunar cycles…

Groupthink.




This is the tendency to deviate from critical thinking and conform to group opinion or make decisions based on the views of those around them. For example, if many people decide to invest in a specific asset, an investor may follow this trend without sufficient analysis. And many people, as a rule, refers to just a few in the information field.

Research

Research confirms the influence of emotional intelligence and demonstrates a direct link between emotions and financial behavior. Investors with higher EI make more rational decisions, show greater investment profitability, and better cope with stress. Studies by the World Health Organization indicate that financial stress often provokes anxiety, depression, and insomnia. Research from the Massachusetts Institute of Technology showed that traders with high stress levels made less profitable decisions. By the way, you can visit my Telegram channel and access a free checklist on financial stress.

How can emotional control affect financial outcomes?

Time for stories. Of course, there are positive examples of overcoming emotional barriers. For instance, investor Warren Buffett is known for his ability to control emotions and not succumb to panic during market downturns. This has helped him build a multibillion-dollar investment portfolio.

The story of the biblical King Solomon is renowned for his wisdom and prudence in decision-making, particularly regarding the allocation of resources and the management of his kingdom’s economy.

The success story of investor Benjamin Graham, who advocated for basing investment decisions on facts rather than emotions and subjective impressions. This approach helped him and his students achieve stable profits.

The well-known case of Alibaba founder Jack Ma, who, despite hundreds of rejections, continued to believe in the success of his startup due to his inner motivation and emotional resilience.

The success story of John Templeton, founder of the Templeton Growth Fund, also demonstrates the importance of developing financial emotional literacy. He used his knowledge of how emotions affect financial decisions to make better investments and increase his wealth.

In general, experienced investors are well aware of the impact of emotions on the market and even take advantage of opportunities, but they are not immune to common cognitive errors, which also occur regularly. Therefore, each of them has their own methods and tools for self-improvement.

What to do to be emotionally literate in finance?





  • Keep a journal of financial decisions and your emotional reactions to them before and after. Analyze your entries for a better understanding of your emotional patterns.
  • Before making significant purchases, take a pause of 3-5 days to make decisions more rationally, rather than under the influence of emotions.
  • If you feel a strong urge to make a purchase, imagine the consequences of that purchase in 1 month and 1 year. This will help you see the long-term perspective.
  • Break down a significant financial goal into specific small steps with clear deadlines. This will increase the likelihood of achieving it.
  • Identify 3 signs that will help you recognize the manifestation of fear or greed when making a financial decision. For example, rapid heartbeat, excessive sweating, and haste.
  • Consult with 2-3 independent experts before making a significant financial decision. Compare their advice for a more objective assessment.
  • Set aside 10% of each significant profit into a separate account before spending the remainder. This will help curb emotions.
  • Develop breathing control and meditation skills. This will help you better cope with financial stress. It requires just 10-15 minutes a day, a small break that even the busiest entrepreneur can find.

Thus, to improve your financial outcomes, one of the key skills is the ability to identify your emotional reactions and manage them to make informed financial decisions. This requires self-analysis, reflection, and the development of emotional intelligence. You can gradually develop this skill, and it is also beneficial not only for the financial aspect of our lives but for various areas as well.