When money matters cause stress

By Chrisa Gresset, Riccardo Calcagno and Brice Corgnet
Posted on May 24, 2019

Whether we like it or not, we have to make financial decisions all the time. To save or to spend, to borrow or not to borrow, at which interest rates and for how long? Studies show that most people have terrifyingly bad money habits, often saving too little, or borrowing too much at high interest rates. Why do we tend to make poor decisions when it comes to our finances?

It is generally accepted that in order to make sound financial decisions, financial literacy is essential. Financial ignorance tends to lead to financial mistakes. But what if there is more to this picture? Could it be that financial decision-making itself induces stress, which in turn leads to poor outcomes? Do people with less financial knowledge perhaps feel more stressed when faced with financial decisions?

Avoiding the vicious circle of stress

If you look at it this way, poor financial outcomes could induce stress, thereby leading to further financial mistakes. A vicious circle so to say. When we feel stressed, our body responds by activating two main interconnected pathways that release stress hormones (adrenaline and cortisol) into the bloodstream. The stress response is an adaptive process designed for survival, for instance when being threatened. Circulating stress hormones cause many changes in the body, such as increase in heart rate, blood flow, respiration and muscle strength. However, when we are required to make clear decisions under stress, our thinking often becomes clouded, leading to critical mistakes.

Studies have shown that when it comes to decision-making during stress, we tend to focus more on the pros rather than the cons, paying less attention to the negative outcomes. Moreover, there are clear gender differences: under stress, women are inclined to act more conservatively, while men tend to take on more risks. These findings have important implications in financial decisions in both investing and borrowing choices. For example, focusing on the benefits of immediate gratification, could lead one to bypass the consequences of going into debt or delays in saving for retirement.

“Are financial mistakes caused by innate cognitive biases or high level of stress? We will test it in an experiment where psychophysiology meets finance!”

What’s to blame: stress or bias?

An alternative explanation as to why people make financial mistakes, is that they suffer from cognitive biases, such as the exponential growth bias. Most of us tend to underestimate growth and future values, because exponential growth is a counterintuitive concept that we are inclined to linearize.

The purpose of our study is to verify whether financial mistakes are due to innate cognitive biases, or caused by the high level of stress felt whilst making the decision. Our research approach is interdisciplinary: psychophysiology meets finance. We use experimental methods to assess whether financial decision-making generates stress in people, and we examine how people under stress make financial decisions.

We will run several experimental sessions in a controlled laboratory environment. All participants will play a financial game that consists of two parts:

  • They first perform a real effort task so as to earn their own money, which has been proven to be important in making the experiment more realistic and valuable.
  • With the hard-earned money, they will then be asked to make basic investment and borrowing decisions.

The experiment is split up into several periods with various interest rates and duration options. With the cash available in each period, participants need to decide how to invest their money, or to opt for a default option. Our experimental treatments will vary the complexity of decisions, the relevance of the financial decision relative to the money earned, as well as specific training sessions aimed at improving financial decision-making. We will also collect individual characteristics, mostly related to personality traits, cognitive ability and demographic background.

Throughout the experiment, we will be monitoring stress levels using a well-established biomarker: heart rate variability. This is determined through an electrocardiogram (ECG), measuring the electrical activity of the heartbeat. When we feel stressed, our heart rate increases and variation between heart beats decreases.

Improving household financial outcomes

We’ve come up with three main outcomes from our experiments:

  • That financial decisions generate stress in most people.
  • That making financial decision under stress lead to more financial mistakes.
  • That stressed-out people are more likely to opt for the default options.

By answering our research questions we can reveal important information on how to improve household financial outcomes:

  • Is financial education the right answer to poor financial decisions? How should we design better financial training programs?
  • Or should we rather focus on the decision-making itself, taking into account that it is this process that causes stress – hence mistakes? Would counselling be a more effective intervention to improve people’s financial decisions?
  • How effective are “just in time” educational or training interventions in reducing stress?

Our research will appeal directly to both individual investors, who will learn how to make better financial decisions and stress management skills, and financial intermediaries, with guidance on how to better help their clients to manage financial matters. But we hope that our research will also help policy makers to intervene more efficiently, for example with just-in-time counselling, competent and unbiased advice, the design of default options, or nudges.

This project is a TFI short-term research grant winner. Chrisa Gresset is a PhD candidate at EM Lyon Business School. Riccardo Calcagno and Brice Corgnet are co-researchers on the project, and both are Professors of Finance at EM Lyon Business School.