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  • The Influence of Emotions on Financial Decision-Making

    Sep 1, 2022

    IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities.  Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog article has been provided by Louie Jachim of Fremont Capital (www.fremont-capital.com):

    The Influence of Emotions on Financial Decision-Making

    Everyone has made a handful of key decisions in their life that have resulted in defining changes in their personal circumstances. Common pivot points are the jobs we take (or leave), the partners we choose, the cities we move to/from, and financial investments we make. If you reflect on these key moments of decision, they all have one thing in common: An intense and influential emotion preceded the decision to act, and likely impacted our choice far more than we were aware.

    In general, it’s easy to consider ourselves perfectly rational economists in personal and business decisions. We think, “Which choice will minimize losses, and yield the greatest utility?” In the moments of decision, particularly those that are financial, our brains work overtime coming up with mental T-charts, pros/cons, outcomes, and probabilities of success. However, much like the iceberg metaphor, these mental mathematics have a limited influence on our resultant decision.

    When it comes to finance, the numbers often make one case, but your emotional framework has competing incentives. The common perception is that data, logic, and objectivity form the framework for decision, and the ensuing emotion is the result of this calculated decision.

    In actuality, people tend to make emotionally-driven decisions, and then justify and rationalize their choice with numbers and data – not the other way around. What truly drives financial decisions (both at the firm and individual level), is what emotional feeling the decision will result in.

    Have you ever known a company or individual facing a financial decision where the economically favorable decision is quite clear, yet they are entirely resistant to it? Has this ever happened to you? (Of course it hasn’t, we make perfectly rational decisions 100% of the time!)

    We have all heard someone say something that embodies this. Examples include:

    1. “Increased order volume shows that customer demand has grown, but ownership doesn’t feel it’s the right time to expand our new product line. The economy is too fickle.”
    2. “I was offered a higher price to sell my company than I ever anticipated, but my gut tells me that it’s not the right (circumstance/time/buyer) to sell.”
    3. “My financial planner showed me that if I don’t start contributing more into my retirement account, I might not meet my savings goal, but I would have to give up the experience of my current lifestyle.”
    4. My investment nearly went to zero and it’s eating me up inside. It’s so painful to hold.”

    The perfectly rational thing to do in each of these cases is exactly the opposite of what the firm/individual actually does. This is because emotionally, the outcome of the “rational” decision is deemed to produce more pain than pleasure. As an aside, it should be noted that it’s scientifically proven that people will do more to avoid pain than to gain pleasure. So, whether we like it or not, our emotional perception of the outcome of a decision is a far more powerful determinant than our logical, objective analysis.

    Here’s what the individuals above are really saying:

    1. Despite our growth goals, our fear of financial loss far outweighs the achievement of sales growth. We’d rather stay stagnant and familiar than grow through natural uncertainty.
    2. I’m not ready to let go of my business. I am too emotionally bonded with it and the pain of losing that bond outweighs the pleasure of an outsized payout.
    3. The pain of letting go of a perceived status and material purchase power is more than the pleasure of knowing I will have a secure retirement X years from now.
    4. If I don’t sell now, I won’t be able to tolerate the torment, regret, and self-doubt of knowing I lost so much money. The pleasure of recouping my losses by being patient doesn’t compare to the relief of getting rid of this awful investment right now.

    Disclaimer: I am no hypocrite. I have made foolish investment decisions that are entirely recoverable, but sold the next day because I can’t bear to see the paper loss. I have said no to interviews with companies that pay a significantly higher salary and offer tangible upsides, because I was comfortable with what was familiar. I have foregone savings for then, to enjoy a lifestyle for now.

    We are all human beings, and our ability to call on both emotion and reason is what gives us the ability to make such dynamic and life-changing decisions. And in a world of Spocks, there would be no creativity, no spontaneity, and no uncertainty – it would be quite a boring place.

    So, next time you are faced with a challenging financial decision, I invite you to increase your awareness of what is really steering the ship. The sails (logical, visible, objectively oriented, what everyone sees first) or the rudders (emotional, below the surface, powerfully directing the vessel, not easily visible).

    If you find yourself knowing Option A makes more financial sense, but for the life of you feel compelled towards Option B, here are a few strategies of how to minimize unhelpful emotional influence in an important decision.

    • Healthy Disassociation
      • Oftentimes, emotions obscure decisions quite intensely because it’s us who’s feeling them. Try envisioning a close friend, family member or colleague who is facing your identical decision but with their own finances. How would you advise them? Is it easier to point them in the economically practical direction? Do you notice that your advice to them might be incongruent with your own self-talk? If so, these are the areas where your own emotions may be obscuring your analysis.
    • Imagine the Absolute Worst Case
      • Let’s take fear and apprehension towards a business purchase as an example. Imagine that you close on the business, and a year later despite your best efforts, sales have declined, staff has turned over, and you must liquidate and file bankruptcy. This is a painful thought and undoubtedly an extreme exercise, but it puts an absolute on your negative emotion (of fear, apprehension, embarrassment). Identifying exactly what the worst case would be allows your emotional treadmill to “take a rest.” Since you’ve already defined how bad things could get, there’s no more rabbit hole to go down. Knowing your “absolute worst case” creates a more well-defined thinking space in which to consider other factors, including compelling upsides.
    • Identify the Desired Feeling
      • What is the feeling you are seeking in your financial decision? And it’s okay if the answer is “higher income.” But there is a feeling underneath that. Is it freedom? Time? Respect? The thrill of the deal? The sense of power this new investment gives you (e.g. house, car, business)? Once you get honest with yourself about what you’re really seeking, this helps objectify the financial aspect. When you realize there are other means by which to achieve this feeling, you may be able to assess the economics without less emotional interference.

    There is a reason for countless books on the “art of the deal,” “gut feelings,” and the “science of achievement.” A decision will never be contemplated without both logic and emotion, and having the ability to utilize both is a key attribute to success. However, it is important to be aware of when emotions are additive (intuition, empathy, passion, excitement), and when they are obscuring (anger, fear, doubt, revenge). Awareness of your emotional state is one of the most important factors that influences the outcome of a financial decision

    Louie Jachim is the principal of Fremont Capital, LLC, a Pacific Northwest-based commercial loan brokerage and debt consultancy helping clients effectively source and structure optimal financing at the most competitive terms. Previously, Louie worked in commercial banking for seven years as a Commercial Relationship Manager, and currently works as a Credit Officer for a private lender providing small-ticket equipment and working capital loans in the western United States. For more information or to connect directly, visit www.fremont-capital.com , call  (425) 577-8871, or email Louie at louie@fremont-capital.com.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.

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