Despite tremendous economic growth and technological advancements in recent years, we live in a time of great volatility, when our own personal financial situations are less predictable than perhaps ever before. In the last couple of years alone, the recent global pandemic has not only caused millions of deaths but also forced many millions more to leave or change their jobs. So how do these types of stressors affect our financial decisions? Let’s take a quick look.
Making good financial decisions is never an easy task. It involves considering some things that are fun for us in the short term, and other things that are good for us in the long term. It involves dealing with complex questions, such as how to budget expense payments or whether to take out credit. In general, these are not things that we as a people excel in, to say the least.
But the challenge of making good decisions gets even worse when we are stressed. A very informative study on this topic was carried out in India. In that study, researchers looked at farmers, who harvest sugar cane. Sugar cane is a seasonal crop, and these farmers generally have low and unsteady incomes. They make their money during harvest season, when they can sell the sugar cane. But, six weeks before the harvest, they are invariably broke. In this particular study, the researchers administered an IQ test to a sample of farmers six weeks before their harvest, and then again just after the harvest. Of course, this was not a standard IQ test, because many of those individuals could not read or write, and so they used a test that involved abstract images. Nevertheless, the findings of that study suggest that the farmers had about one-third lower IQ scores when they were under financial distress before the harvest, compared to after the harvest.
The term for this phenomenon is called “scarcity mindset”. The notion of scarcity mindset is that for individuals who are financially stressed, part of their brains is continuously busy with trying to figure out the uncertainty of the future income, as well as when their next payments need to be made. And this causes a lot of stress and unclear questions. For example, a person may ask themselves: Will I be able to afford my expenses? Should I have waited to purchase that item? Do I have enough money for lunch, or should I rather save that money for my medication? Will I be able to pay my rent? What about my loans? And so on…
All of these uncertain thoughts take away from one’s mental capacity to make good financial decisions. The same can be said for people who are busy multi-tasking with other things while at work, for example. While tending to ones’ kids, or trying to fix something at home, part of one’s mind is going to be occupied with these tasks, and much like in the IQ test, they will be able to devote less of their full mental capacity to the work-related tasks. Of course, this doesn’t mean that people’s actual mental capacity goes down. Rather, when they are stressed, people have fewer available resources to deal with other important things.
If you think that this is sad news, you are right. But it gets worse, unfortunately. It gets worse because one of the main things that people normally rely on recover from stressful situations is the support from their social network. ‘Resilience’ is a term used to describe how we’re able to “pop back up” from hardships and overcome life’s challenges. But a critical aspect to overcoming such challenges is to share our feelings and experiences with trusted others, in order to get genuine sympathy, emotional support, and advice. It seems that while we are good at sharing information about our stressful personal relationships (e.g., complaining about your spouse), when it comes to matters of money, sharing our financial stresses with our social network is something most of us would prefer to avoid.
To highlight this phenomenon, an article was once published in an American newspaper, claiming that American men are much more likely to admit to their friends that they use Viagra rather than to admit they are in credit card debt. This is because, in general, we tend to view financial hardships as personal failures, and so we are less likely to share this information with those close to us. As a result, in many such cases, we would not get the important social support that would otherwise help us recover.
Taking these two factors together — scarcity mindset and a lack of social support — suggests that when people get into a financial hardship, a vicious cycle can form, and actually spiral to become worse. At first, the financial hardship itself creates stress which decreases one’s mental capacity and impairs decision making. These bad decisions may in turn cause additional hardships, on top of which, the recovery from the growing stress will be hindered without the support from others.
The solution to avoiding this vicious cycle, of course, is neither easy nor clear. However, once we understand the intensity and complexity of the problem, we can begin to work towards helping others (and ourselves) in trying to fix it. For example, it would make sense for people to refrain from making any serious financial decisions while they are feeling especially stressed. Instead, it is advisable to try and postpone such decisions (as much as feasibly possible), until they feel more calm and relaxed. In addition, having a trusted advisor with whom one confides in on a regular basis, such as a friend or therapist, may make it easier to share information with that person when specific hardships arise.
Financial hardships are inevitable in life, but by understanding some of the emotional factors that may affect our behaviors in such situations, even small interventions may help us lead to better and more rational decision-making.