The Science Of Making More Money Using Emotional Intelligence
- Apr 13, 2023
- 5 min read
Written by: Cort Twitty, Executive Contributor
Executive Contributors at Brainz Magazine are handpicked and invited to contribute because of their knowledge and valuable insight within their area of expertise.
When it comes to investing, it's natural to focus on the potential gains. After all, the promise of making money is what draws many people to the stock market, real estate investing, or other investment types. However, research has shown that our investment losses hurt us more than our gains help us. This is true with investing, and this is true with our emotional response to investing.
First, to the investment side of things. If I invest $100 and I lose 50% I’m left with $50. Pretty simple math. The next day I gain 50% back, so I’m back to a $100, right? Not exactly. 50% gain on $50 leaves me with $75. Which means that if I lose 50% on my money, I must gain 100% to get back to my original investment amount of $100. This is a basic example of why losses hurt us more than gains help us.
But if we look beyond the numbers to the people investing, we find that something else is happening. People feel emotional pain when they lose money more than they feel pleasurable gain from making money.
Surprised? Don’t be! This phenomenon is known as loss aversion. Loss aversion is a cognitive bias that refers to the tendency of people to experience stronger negative emotions in response to losses than positive emotions in response to gains of equal magnitude. This phenomenon has been widely studied in the field of behavioral economics and has been shown to have a powerful impact on our decision-making and financial behavior.
Research has found that the emotional impact of loss aversion is particularly strong when it comes to financial losses. A study conducted by psychologists Daniel Kahneman and Amos Tversky found that the pain of losing $100 is about twice as powerful as the pleasure of gaining $100. This means that even if we stand to gain more than we stand to lose, we may still be more motivated to avoid losses than to pursue gains.
As a result, investors may be more likely to make irrational decisions in response to losses. When the market experiences a downturn, investors may feel the urge to sell their holdings to avoid further losses, even if the long-term prospects of the investment are still sound. This can lead to missed opportunities for growth and ultimately hurt their investment returns.
People don’t withdraw their money from the market because they’re foolish, they withdraw their money from the market to avoid further losses because they are hurting and can’t stand further emotional pain. This author is suggesting that using the loss aversion principle, emotional intelligence is twice as important as being nifty with money. There are very few investment professionals that work on emotional intelligence twice as much as they work on knowing investment intelligence.
Loss aversion can also lead investors to focus too much on short-term fluctuations in the market, rather than taking a long-term approach to investing.
Financial professionals are looking at the numbers constantly, the ebbs and flows, patterns, anything they think will help give them an edge with their clients. But doesn’t loss aversion make you pause and think that mastering the human condition might be at least as important as the numbers themselves?
So, what can investors do to overcome loss aversion and make more rational investment decisions? Researching the human psychology behind the numbers is vital. And to a large degree, the finance industry has lost sight of this. Imagine if you can master both the investment strategies and get to know your client so well that you know they are going to be hurting if their investments haven’t been doing well?
By this point, they may not need to hear the importance of staying in the market and the long-term benefits of doing so. They may need you to identify that they are likely hurting and feeling like they got gut punched. Empathize with them. Share in their pain and acknowledge that every day isn’t a good day.
Try to focus on the long-term outlook for the investment. By taking a big picture view and considering the potential returns over a longer time horizon, investors may be less likely to be swayed by short-term market fluctuations.
Another strategy is to diversify your investments. By spreading your investments across different asset classes and sectors, you can reduce your overall risk and potentially mitigate the impact of losses in any one area.
It’s important to keep emotions in check and avoid making impulsive decisions based on fear or greed. By sticking to a solid investment plan and avoiding knee-jerk reactions to market movements, investors can improve their chances of achieving their long-term financial goals.
Don’t assume because your own emotions are in check that your clients are too. 47% of clients with an advisor wish they heard from them more. Less transactional communication and more empathy toward the pain they’re feeling is much more beneficial in the long run.
22% of surveyed clients of advisors (29% with more than $500K of AUM) switched to a new advisor since 2020. While we don’t know the emotional aptitude of the new advisors, this statistic should be troubling to advisors that think their pre-pandemic way of doing business will still work. People have evolved, industries have evolved, and emotional intelligence has become a key part of every business.
If a client loses money in the market, they don’t need you to rattle off why this happened, providing them with excuses like blaming outside forces or political policy. According to loss aversion, they need a friend…in a bad way.
This article is written for the potential investors out there who may not have a financial professional yet…most don’t. Choose someone who asks emotional based questions and gets to know you before they get to know about your assets. Quite frankly, for those that aren’t training themselves on emotional intelligence, they are falling behind.
But don’t beat yourself up. We have a 2-million-year-old-brain that is designed to protect us and keep us safe. That is the dominating factor of loss aversion. The reason for this is that our brains are wired to prioritize survival over pleasure. In the past, the ability to avoid losses was essential for our survival, as losing resources like food, water, or shelter could have life-threatening consequences. As a result, our brains have developed a heightened sensitivity to losses, which can lead to irrational decision-making in the face of potential losses.
Finally, loss aversion is a powerful force that can influence our investment decisions and potentially hurt our returns. By taking a long-term approach, diversifying our investments, and keeping emotions in check, we can overcome this bias and make more rational, successful investment decisions. Choosing who you work with is one of the most important decisions you can make. Take your time, interview multiple advisors, and try to stay in investment vehicles that are routed through insurance companies so that you get the added benefit of a guaranteed no loss investment.
When structured correctly, these investment options are among the best options to minimizing tax burden to the IRS, in addition to the previously mentioned benefit of no loss guarantee.
I wish you luck on your journey through the ever-changing landscape of financial investing.
Cort Twitty, Executive Contributor Brainz Magazine
Cort Twitty, homeless as a child with a learning disability made him curious about what made people happy? Twitty saw that money made people happy, so he learned how to make money at a young age. Then he lost his money. The harder he tried, the more money he made and the more money he lost. He began studying the correlation between mindset and money. Mr. Twitty is now the foremost authority on money, emotions, and the ugly connection between the two. In 2017, Twitty opened Steele Artistic Business Solutions where he teaches about both subjects. In his spare time, he leads a team of dedicated financial advisors who help families learn how to make their money work for them, not them work for money.
