The Irrational Effects of Financial Trauma

By:  Jim Edwards, CFP ® | Financial Advisor & Portfolio Manager

Financial trauma can occur through a variety of means. It can occur on a personal basis such as a job loss, bankruptcy, or divorce. It can also occur systemically through stock market and real estate  losses like those experienced during the recent recession of 2008. Once the events have transpired, though, their effects can impact our future behaviors for years, if not a lifetime.

Our experiences with money and financial security are deeply rooted in all of us.  These experiences activate our primordial concerns about safety and security. We cannot perform the essential functions of feeding, clothing, and sheltering ourselves without the means to somehow pay for these things. In fact, some neuroscientists have hypothesized that powerful financial losses or chronic poverty might register within our limbic systems (the part of the brain involved in our emotions and motivations, particularly those that are related to survival) creating an embedded neural circuit that overrides more reasoned thinking  and  decision  making.

A good example of this is the effect that the Great Depression had on the habits of those who lived through it. Years of impoverishment taught people to continually save and to never throw away anything that might possibly be reused.  If you have ever been around someone who lived through the Great Depression, you might have seen them saving used plastic bags or freezing and re-freezing every leftover scrap of food.

A compulsion to save, combined with reluctance to spend, became the paramount characteristic in the financial lives of those who survived this period of extreme poverty. But while the effects of the Great Depression on people’s financial lives is a notable example, less storied and more personal events—financial losses due to personal bankruptcy, business failures, costly illnesses, and/or divorces—can have an equally powerful effect.

However, continually responding to these powerful shapers of our experience can sometimes lead us down the wrong path to chronic, repetitive errors in financial judgment. Because these powerful negative experiences connect to deep emotional states, they can mistakenly drive us into decisions that are irrational and/or unproductive.

For instance, the fear of loss can result in investors being overly conservative in their investment styles. Such persons might only invest in “safe” securities—certificates of deposits or money markets, for instance—subjecting themselves to real losses in purchasing power due to the effects of inflation over time. In other instances, one bad experience with a financial advisor could lead someone to decide that all financial advice is bad and that they cannot rely on anyone but themselves, even if it is in their best interest to get outside help. Such people continue to refuse advice, even when there is ample evidence that shows they might not be managing their investments well.  If they were to use the same logic  with their health, they could risk tragic consequences by refusing to seek a second opinion or even another physician, erroneously concluding that all medical advice is bad.

Traumatic financial events can also create a sense of hopelessness about the future. I have known clients who grew up in communist countries where their families and relatives lost everything to the state. Despite accumulating significant wealth in our democracy, they believe that what happened to their families will happen to them—so they do little-to-no  financial planning.

In all of these situations, when powerful experiences are inhibiting good decision making, the best remedy is to ask, “What do money, spending, and saving mean to me?” The answers often help to make sense of behavior around money. By standing back from the deeper issue, we can begin to separate the negative behaviors related to past traumatic experiences from those that could be beneficial in the future.

If you or a loved one is stuck in financial  neutral and could benefit from objective financial advice, give us a call—we are here to help.