By Nelson Nyoro
Human emotions and cognitive biases play a critical role in the investment decisions of managers and investors. Emotional intelligence (EI) has a bearing on the efficacy to cope with emotion eliciting issues involving money. According to Mayer (1990), emotional intelligence is the cognitive ability embodied in the overall intelligence structure that helps individuals to identify, process and manage emotions. It has otherwise been defined as the ability to motivate oneself to achieve in one’s profession or goals (Boyatzis, Goleman, & Rhee, 2001). Aspects to do with resilience, consistency, self control and stamina all represent emotional intelligence.
The relation between money attitudes and emotional intelligence (EI) is of special interest because research has shown that money tends to be imbued with salient emotions (Ennis, Hobfoll, & Schroeder, 2000). Monetary issues also tend to have a profound impact on emotionally significant relationships (Conger et al., 1994). Forman (1987) similarly found that money behaviour is hardly rational, but rather, it is governed by powerful and often unrecognized emotional forces. In all these studies, they strongly suggest that attitudes about money seem to be determined by the ability to manage emotion-related issues, as encountered both in the social and professional realms. EI is for this reason a potentially useful concept in order to study the extent to which individual differences in money attitudes may be explained by emotional competence.
This training is meant to help investors overcome their biases so that their financial decisions can be less than fully rational. Human decisions often depend on their nature, intuitions and habits as well as cognitive or emotional biases hidden deeply at the back of one’s mind. Examples of these biases include:
- Overconfidence and over optimism
Investors overestimate their ability and the accuracy of the information they have. They also under estimate risk and exaggerate their ability to control events (illusion of control). Having illusion of control makes one loss money and focus. People are wrong too often when they are certain that they are right.
Investors assess situations based on superficial characteristics rather than underlying probabilities.
Forecasters cling to prior beliefs in the face of new information.
Bias investors overstate the probabilities of recently observed or experienced events because the memory is fresh.
- Frame dependence and anchoring
The form of presentation of information can affect the decision made.
- Mental accounting
Individuals allocate wealth to separate mental compartments and ignore fungibility and correlation effects.
- Regret aversion
Individuals make decisions in a way that allows them to avoid feeling emotional pain in the event of an adverse outcome.