How emotion and logic affect financial decisions

One of the key assumptions of economics is that people behave rationally. That is, they tend to select products logically after weighing the costs and benefits. But as humans, we know that’s not always true — humans are driven by emotions. Therefore, we need to be mindful, intentional, and logical when making decisions with money.   

What is rational choice theory?  

Rational choice theory is a model that economists use to predict how shoppers will behave. A fundamental assumption of rational choice theory is that people buy things that they can get a lot of use of for the lowest price.   

But humans are complicated, and sometimes, our decisions don’t always make financial sense. For example, humans often behave in ways that satisfy them emotionally, socially, or intellectually, even if those behaviors are more costly.   

Awareness of your emotional nature can help you become a savvier consumer.   

Hacks to make more rational consumer choices  

Data shows us that consumers don’t always make the most rational choices regarding spending. For one, they may not have complete information about their options. Biases, emotions, or outside factors such as advertising may also influence them.   

Fortunately, there are some things you can do to help make more rational consumer choices. Here are five hacks to help you be a more rational consumer:  

Avoid making emotional decisions 

If you’re an emotional consumer, you probably choose based on feelings rather than logic. For example, you might choose a product because it’s aesthetically pleasing, your friends will think it’s cool, or because you have a personal connection to the company.   

While there’s nothing wrong with making occasional emotionally driven purchases, it’s important to be aware of the dangers of letting emotions rule your spending habits.  

One of the biggest dangers is spending more money than you need to. For example, let’s say you’re out shopping for a new outfit and finding a dress you love that is out of your price range.   

A rational consumer would continue looking for a cheaper option that also meets their needs. But an emotional consumer would be more likely to rationalize the purchase, telling themselves that they’ll wear it all the time and it’s worth the extra money. As a result, they end up spending more money than necessary.  

Beware of behavioral biases 

Behavioral economics is a field of study that looks at how people actually make decisions, as opposed to how they should make decisions according to economic theory.   

Several common biases can lead you astray. For example, confirmation bias may lead you to seek information that supports your beliefs and ignore information that contradicts them. This can lead to poor choices because you are not considering all the available evidence.   

Another common bias is loss aversion, which means you’re more motivated by the fear of losing something than the prospect of gaining something. This can lead to irrational decision-making because you’re more likely to hold onto something losing value rather than selling it and investing the money elsewhere.   

By being aware of these biases, you can try to overcome them and make more rational consumer choices.  

Weigh all options carefully 

To make rational consumer choices, it’s essential to thoroughly weigh all available options. When purchasing, look at a few options and think hard about what’s most important to you. Even if you have your heart set on one product, look for a less expensive alternative.   

Try to be open-minded as you shop around for the best deal. For example, if a more affordable product with the same features as a previously considered option becomes available, the rational consumer would choose the cheaper option.  

Uncouple money from happiness 

The idea that money doesn’t buy happiness isn’t completely true—the comfort and peace of mind that comes with financial stability can offer a major sense of contentment.   

But more money doesn’t hold the same value at a certain income level doesn’t hold quite the same value. And besides, the best things in life are free. Check-in with yourself; when are you the happiest? No matter your financial situation, prioritizing your happiness will make you feel more at peace.   

Consider your future self 

To make rational choices, consider your actions’ short-term and long-term consequences. Unfortunately, many people make irrational choices because they only think about the immediate implications of their decisions, which can be costly in the long run.   

Suppose you buy a new phone because it’s on sale, even though you can’t afford the monthly payments. In the short term, it may seem like a good deal. However, in the long term, it will likely cause financial hardship.   

On the other hand, as a rational consumer, you would think ahead to the future and consider the potential consequences of your choice. You can make more rational consumer choices by taking the time to think about the long-term ramifications of your actions.  

Final thoughts on rational choice theory 

By weighing up the costs and benefits of each financial decision, you can always be sure you’re making informed choices that are in your best interests. In addition, you can make better choices about prices, products, and investments by understanding how to align your personal finances with your values. Ultimately, rational behavior leads to greater financial wellness.