Sadness Screws up Financial Decisions–Be Happy!

/Sadness Screws up Financial Decisions–Be Happy!

Sadness Screws up Financial Decisions–Be Happy!

By | 2017-08-18T16:57:13+00:00 August 1st, 2013|Behavioral Finance|5 Comments

The Financial Costs of Sadness

  • Lerner JS, Li Y, Weber EU
  • A version of the paper can be found here.
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Abstract:

Hundreds of studies have examined the “sadder-but-wiser” hypothesis—that sad people make wiser decisions—and most find support for it. But virtually no tests of the hypothesis examined financial decisions, which are some of the most frequent and consequential decisions people make. To address this gap, the present experiments examined the effects of sadness on intertemporal financial choices of the form $X now versus $(X+Y) later—typical of the choices people make when considering whether to spend now or save to spend more later. Studies of intertemporal choices typically reveal extreme impatience. That is, people choose earlier rewards over significantly larger, later rewards, often leading to regret. Would sadness reverse the typical impatience pattern in choices—by increasing wisdom and decreasing impatience—per the sadder-but-wiser hypothesis? Three experiments tested the hypothesis, inducing sadness in randomly assigned participants and then offering participants an intertemporal financial choice unrelated to the source of sadness. Each experiment found that sadness dramatically increased impatience: Relative to the median neutral-mood participant, the median sad-mood participant was willing to accept 35% to 79% less money today to avoid waiting for a payoff. Sadness increased impatience even though the emotion was normatively irrelevant to the choice. In sum, sadder is not wiser when it comes to making tradeoffs between time and money.

Data Sources:

Experimental data.

Alpha Highlight:

“Exponential Discount Factor” is a measure where a lower value represents more impatience. People in a sad state tend to be more impatient.

ssrn-id2291030

Strategy Summary:

  1. Don’t make financial decisions when you are in a sad mood.
    • Sad people tend to desire an immediate benefit at the expense of a larger long term gain.

Commentary:

  • Never trade while sad; Drink strong whiskey when you are sad.

 

Any experience trading sad?


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About the Author:

Wes Gray
After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.