MEIR STATMAN, a finance professor at California’s Santa Clara University, argues that financial decisions—like everyday consumer purchases—have three benefits: utilitarian (what it does for me), expressive (what it says about me) and emotional (how it makes me feel).
As we manage our finances, we insist our goal is strictly utilitarian, and that all we want to do is make money. But in truth, we often make decisions for expressive or emotional reasons—and these other motivations can hurt our stated goal of greater wealth, as Prof. Statman explained in a recent Wall Street Journal article (subscription required).
For instance, we’re proud to own a hedge fund or hire a private money manager, despite the high fees that make it unlikely we’ll earn market-beating returns. We get a thrill out of trading and we enjoy spending money, though high trading typically leads to lower returns and spending means we save less for retirement. We’re proud to sell our investment winners, even though it can mean paying capital gains taxes. Meanwhile, we regret our losers—and we don’t want to make the regret worse by selling and abandoning all chance of recouping the loss.
This, alas, is one area where knowledge is unlikely to set you free. You may know intellectually that you ought to spend less, dump your losing stocks and get rid of your high-cost actively managed funds. But you don’t change your financial ways, because emotions often trump rationality. My advice: Try talking to your spouse or a friend about your finances. It’s easy to convince yourself that you’re being logical when it’s just thoughts rattling around in your head. It’s much harder when you have to articulate those thoughts to others.