Behavioral Financial Advice 101: Understanding Emotional Intelligence and Competence

By: Kaplan Financial Education
March 22, 2019
Illustration of how the brain and the heart both contribute to financial decision making

Did you know that most equity mutual fund investors tend to underperform the S&P 500? This includes investors who seek out and utilize the help of financial advisors. It’s true. The annual performance of the S&P between 1995 and 2014 was 9.85% while the average performance of an equity fund investor was just 5.19%. The biggest explanation, by far, for investor return being so much lower than the S&P is bad investor behavior, as saving and investing behavior account for 87% of portfolio growth. 

Emotions have a lot to do with financial decision-making. When we get emotional, our bodies want us to respond very quickly, and snap decisions are usually wrong.

It's when we don't realize we are getting angry that we tend to make poor decisions or go against our core values and beliefs. The brain is hardwired to reflex before it reflects. An emotional response takes 12 milliseconds while a cognitive response takes 40 milliseconds. This is good if you are trying to escape a burning building, but it poses challenges if you are making investment decisions or solution selling.  

The relationship of investor performance to the S&P 500 and our emotional and psychological behavior is important to share with clients and prospects, especially the newest generation of investors. This information can help them to understand the importance of selecting a financial advisor who will coach and advise them to handle their emotions in an appropriate way when making financial decisions.

Emotional Intelligence

Emotional intelligence is recognizing what we are feeling in the moment and being able to differentiate between our emotions.

For example, let's say you get a call from your child's school, and you find out he has been given an out-of-school suspension. Immediately, you feel your breathing become more rapid, and you start rubbing your forehead. If you notice these reactions and understand that they are a result of the fact that you are upset about the situation, you are using emotional intelligence.

Emotional Competence

Emotional competence is managing our emotions. It is the ability to stay focused on a goal in the face of competing emotions. It is also the capacity to create alignment between your goals, actions, and values. Emotional competence is the application of our emotional intelligence.

In thinking about the last scenario, you might recognize that you are getting upset about your child's suspension, which as we said, would show emotional intelligence. However, if you don't do anything to manage those emotions, or you let yourself follow a path where those emotions take you to an undesirable behavior, you would be showing emotional incompetence. Emotional competence is being able to successfully manage our emotions once we are able to recognize them. Being emotionally competent would require you to take a course of action that would have the best outcome.

Managing Your Stress

When we get emotional due to outside stressors, our brains actually shut off our ability to think logically and coherently. When we are cognitively impaired, the following happens:

  • We don't listen as well.
  • We have shorter fuses and often feel impatient.
  • We tend to obsess about the past and/or worry about the future.

All of these reactions will negatively impact our ability to think logically and act rationally, so our first important step is to learn how to calm ourselves down and bring ourselves out of that emotional state. We can then begin to think rationally again.

So what can you do to become emotionally competent?  What will make the difference in your life and the lives of your clients to lessen stress and help you improve decision-making?

  • Work on yourself first.  Before you can help your clients, you need to work on becoming more emotionally competent in your own life.  You need to become more aware of ways you can improve your decision-making capabilities. Once you’ve done it, you’ll have a better idea how much it can impact your life—and how you can help others. 
  • Understand your feelings. In times of high stress, how do you react?  What are you thinking?  What are you doing?  What are some of the patterns in your behavior? What are the most effective ways to calm you down in those times of high stress? 
  • Know your values. What do you look like on your very best day?  What are your values?  What is your ideal self?  Your values can cause stress when you spend energy and time on things that do not align with your values. Knowing your top values and being able to verbalize them are important so you can better work through your stress and emotions.