A Blog by Jonathan Low

 

Oct 23, 2020

The Reasons Covid May Unconsciously Affect Financial Decision-Making

Covid has sparked feelings of anger, sadness or fear, all of which may affect the way people make financial decisions in the short term, which may have negative impacts in the long term. JL

Shlomo Benartzi and John Payne report in the Wall Street Journal:

The reason is what behavioral scientists call “ambient emotion.” Covid-19 has caused a shift in the underlying moods of millions of people. For some, these events have led to feelings of fear, while others have experienced anger or sadness. Research has shown that even fleeting moods can influence decision making.The impact of ambient emotions is especially relevant for older people (because) they’re making decisions with long-term consequences in the middle of a pandemic. Sadness makes people more pessimistic and impatient. Those experiencing anger are likely to become risk-seeking. (Those) feeling scared are likely to delay benefits.

The coronavirus pandemic may be affecting your financial decision-making in all sorts of hidden ways (or in ways you aren’t even aware of).

The reason is what behavioral scientists call “ambient emotion” or background feelings. The impact of ambient emotions has gained attention this year, partly because events such as the Covid-19 pandemic have caused a dramatic shift in the underlying moods of millions of people. For some, these events have led predominantly to background feelings of fear, while others have experienced extended bouts of anger or sadness.

While ambient emotions are easy to ignore—like the effects of background music or the weather, we often aren’t even aware of them—research by Norbert Schwarz of the University of Southern California and Gerald Clore of the University of Virginia, among others, has shown that even fleeting moods can influence decision making.

The impact of ambient emotions is especially relevant for older people right now. Not only are they among the most vulnerable health-wise from Covid-19, they’re making decisions with long-term consequences in the middle of a pandemic. While younger Americans have time to correct their financial mistakes, people who are retired or close to retirement often lack the runway for course corrections.

So how can people recognize the role ambient feelings play in decision-making and keep it from affecting their finances? Here is a guide:

Identify the emotion

The first step is to figure out which ambient emotions you’ve been feeling during the pandemic. To do that, rate the extent to which you are experiencing the following three emotions on a scale of 1 to 7—with 1 being “never” and 7 being “constantly or almost always.”

a. Fear

b. Anger

c. Sadness

The emotion to which you assigned the highest number is likely your primary ambient emotion during the pandemic, especially if you gave it a much higher score than the other choices. (If you didn’t give any of the emotions a high score, then you might be less affected than most by the current crisis.)

Once you have identified your primary ambient emotion, you can take steps to avoid common, and costly, financial mistakes that are caused by these different feelings.

Take those who are experiencing fear, a common response to the pandemic. Research by Jennifer Lerner, a Harvard University professor, shows that people who are feeling scared tend to become more risk averse, even in seemingly unrelated domains. You might be scared of Covid-19, but your risk aversion could influence whether or not you drive faster than the speed limit on the highway.

When it comes to financial decisions, older Americans who are feeling scared by current events could become less likely to delay claiming Social Security benefits. Given the uncertainty of the world, they might choose to get their payments as soon as possible. Unfortunately, this can significantly reduce the amount of money they receive each month for the rest of their lives. As research by the Boston College Center for Retirement Research demonstrates, delaying benefits is equivalent to purchasing an inflation-adjusted annuity that pays out at 6.7% annually. Such a product, if offered, would be a no-brainer.

Those who are experiencing ambient anger should watch out for the opposite effect—research shows that they are likely to become risk-seeking, an effect especially strong among men. For retirees, this could mean drawing down assets too quickly, or potentially selecting a portfolio with excessive risk.

Sadness, meanwhile, tends to make people more pessimistic and impatient. Given that many financial decisions for retirees involve managing the trade-offs between immediate rewards and long-term benefits, such impatience could prove problematic. For instance, they might be less willing to pay now for long-term care insurance, increasing the risk they could run out of money later.

Sadness also can influence our shopping decisions, increasing the amount of money we are willing to pay to acquire goods. Instead of waiting for a sale, a bout of sadness can make us more likely to seek immediate gratification, regardless of the price.

Scientists generally classify sadness as an “avoidant” emotion. When we’re sad, we’re more likely to procrastinate on things such as drafting a will or estate plan. More generally, we may avoid difficult decisions as we approach retirement.

Remove the bias

There are several strategies people can use to minimize the potential negative effects of these ambient emotions on financial decisions.

1. Engage in self-reflection. Drs. Schwarz and Clore showed in their study that weather can impact ratings of overall life satisfaction, and that, in turn, can affect a person’s decision-making. But they also demonstrated that the effect was eliminated if people were reminded that a dreary day can make us feel down. In other words, the weather stops affecting our mood once we realize that it can affect our mood. So before you make any major financial choices during the pandemic, identify the source of your mood.


2. Consider alternative emotions. For instance, if you’re feeling scared, imagine what choices you would make if you were feeling a different emotion. Would they be different? This strategy can help ensure your financial decisions aren’t being unduly swayed by a temporary ambient emotion.

3. Think twice. One proven tactic for reducing bias is to reflect on the decision at different points in time. In much the same way people are often advised to wait a few days before committing to a major purchase such as buying a new car, the goal is to give yourself time to cool off and reflect on the decision in a different emotional state. Of course, during the pandemic our moods might be more stubborn, and we might need to wait more than a few days for our feelings to shift.

4. Give some advice. Imagine you were giving recommendations to someone in your position. What would you recommend they do? A related idea is to imagine that you would need to justify your decision to someone else. If your recommendations differ from your planned course of action, reflect on why, and make sure the differences aren’t due to your ambient emotions.

5. Conduct a premortem. That is, imagine a negative financial outcome, such as running out of money in retirement. Then ask yourself if your current choices making such an outcome more likely?

In the midst of a global pandemic, there is no correct “ambient emotion” to feel. But this doesn’t mean we can afford to neglect these subtle feelings. Unless we acknowledge our ambient emotions, and actively counterbalance their effects, they are likely to influence major financial decisions that will impact our lives for years to come.

Moods may be fleeting. Their consequences can last.

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