The Psychology of Finance

The statement, “psychology and financial matters,” feels like an oxymoron; however, this statement may not be too far from the truth as evidenced by topics such as TARP, the stock market, as well as our personal spending behaviors.

On October 14, 2008, the Treasury provided financial institutions capital via the Troubled Assets Relief Program or "TARP" to help banks stabilize their balance sheet as well as to stimulate the economy. Stabilization was achieved by buying illiquid assets thereby infusing the bank with cash. The infusion of cash was expected to help ensure continued funding for prime borrowers. Many banks took the money, ($300 billion total); however, many of those that received the funds were afraid to lend, fearing that they may lend the money, new assets would deteriorate, regulators would in turn require more capital to cover losses on the new bad assets and we would be back at square one.
Other financial institutions refused receipt of TARP funds for fear of what their shareholders would think of “the need” of Government funds for continuing operations. The problem was systemic and not necessarily indicative of risky behavior.

Descartes once said, “I think therefore, I am,” however, sometimes, we think too much. Neither ideology concerning TARP really served the purpose of TARP - so, we essentially “psyched” ourselves out.

Wall Street
On Wall Street, pricing is more than just a simple function of reward or punishment for actual performance. Pricing incorporates a degree of speculation concerning future performance, based on current sentiment: do we “feel good” about the prospects?

Recently, we have seen huge swings in the stock market, for no real apparent reason. A great example are the swings throughout the later half of 2011. This schizophrenic market volatility is a direct reflection of our global sentiment, which sometimes changes from the time that we went to bed to the time that wake up in the morning.
You may ask, "Why does this happen"? I will refer you to an article on US Stocks ; however, the answer we are provided always remains the same: “fear.”

Personal Spending Behaviors
Shopping is one of America’s favorite pastimes. It implies socializing, happiness, and fulfillment of a need, want, or desire. It releases endorphins into our system. Likewise, when facing a purchase that requires significant consideration, we may experience stress and anxiety.

We all experience this at one time or another. What we do not often speak about is how we trend toward impulse purchases in times of duress. The list is forgotten, rational needs and wants leave the short-term memory and we buy the junk food, the orange shoes, or the fourth umbrella that we don’t require. The focus shifts completely to desire, so that we fill the gap triggered by anger, frustration, confusion, or some other negative emotion. These actions are the direct result of a rampant release of cortisol and adrenaline.

Although I much prefer endorphins, cortisol must kick in from time-to-time. After all, we are only human. Humans created the economic and financial systems, so it should be no surprise that psychology plays a significant role.

About the Author

Maisha Smart, MBA founded Finance and Marketing to help small businesses excel, by bridging the gap between finance and marketing processes. Some of her favorite activities include fine arts, a good debate, and social engagement.

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