Can I Sleep at Night?

Since the dawn of behavioral finance, many traditional economic theories have taken a backseat because of practical shortcomings. Individuals are not rational economic beings and instead make emotional decisions that are suboptimal. One practical decision-making tool that I would espouse to individuals is what I will call the sound sleep principle. When faced with tough decisions, people need to focus on the question of whether I am going to be able to sleep at night with this decision?  

Too many times people fixate on the economics of a decision and don’t tap into how that decision and its outcomes will make them feel. And because many personal finance situations are not cut-and-dry, understanding how your future self is going to be affected by this decision can prove to be helpful in making an optimal decision.  

Also, in personal finance there are no conferences or divisions, or final leaderboard. It’s not a competition. But that’s not what’s embedded in our culture. We constantly hear extreme stories of success and failure because that’s what sells. Instead of thinking competitively about how to maximize the next dollar, we need to take a healthier approach to financial decisions. One effective way to do this is when you are tasked with your next major financial decision, apply the sound sleep principle. Ask yourself if I make this decision, will I sleep better at night?  

Below are a couple of examples to provide context to this idea: 

Situation #1: Should Jack sell his concentrated position in stock X?

• Jack is a retired employee who worked 35 years at corporation X and has accumulated a large low-cost basis stock position. 
• Jack will need some withdraws off his portfolio in retirement but its small compared to the size of his portfolio.  
• Jack is considering a purchase of a second home in retirement.  
• Jack wants to leave an inheritance to his grandchildren. 

As a first step it’s important to objectively look at the situation. A financial plan is a useful tool to accomplish this. For Jack, a plan can comprehensively model out different scenarios for levels of expenses, home purchases, inheritance, and how that affects his overall financial position. This information is a good starting point, but it can’t and won’t be the only driver of the decision.  

This is where Jack needs to ask himself, will I be able to sleep at night with this decision? And it’s not always a question about physical sleep but more broadly about emotional wellbeing. Only after this consideration can Jack make an optimal decision. Let’s look at two different versions of Jack to stress this point:  

1. Our first version of Jack wouldn’t be able to sleep at night if he sold his stock. He has an emotional attachment to that stock. He views it as ownership in a company he proudly served for 35 years. He would feel regret if the stock went higher and potentially ill will to those who recommended a sale. 
2. The second version of Jack would have a different feeling entirely. He is uneasy about the nature of the stock market and doesn’t feel confident about the new executive team in control. Jack holding this type of position would have him obsessively checking screens to watch the stock price. This is exactly what he doesn’t want to be doing in retirement and would keep him up at night.  

This is an example where even though the facts and figures remain constant, the optimal decision doesn’t. Feelings and emotions matter.  

Let’s look at one more example: 

Situation #2: Should Megan and Danny take out a personal loan to renovate their kitchen?

• They do not have a lot of money saved outside of company retirement accounts. 
• They both have steady jobs. 
• Interest rates have risen and are at moderately high levels.  

The best place for Megan and Danny to start their decision-making process is to consider their ability to take this financial risk. Using financial planning software can once again be a good tool. Here Megan and Danny can see how various forms and levels of debt affect their financial standing.  

But once again having those numbers can’t and won’t be the only driver of this decision. They both need to take time to think about how they will sleep at night if they decide for or against redoing their kitchen. Let’s look at two different versions of Megan: 

1. Our first version of Megan may be restless at night because she feels behind financially. This has her hyper focused on details at work and their daily spending. On top of that she is uneasy about the thought of living in construction for months. 
2. Our second version of Megan may not be able to sleep at night because she is sick and tired of her run-down kitchen. Her home is her sanctuary. She knows that this will set them back financially but is confident that it’s just a bump along the road. 

These are good examples not just because investment positioning and spending are so common, but because it shows that the traditional financial advice isn’t always optimal. It would be easy for an advisor to blindly recommend Jack to diversify and Megan/Danny to wait on the renovation, but that isn’t always the best solution. Applying the sound sleep principle can be a good tool to help make better financial decisions. 

THOR has over 30 years of experience guiding individuals with important financial decisions. If you have questions and would like to talk with us further, please call us at 513-271-6777 or schedule a call here. For more THOR reading, click here to go to the Blogs and Market Updates section on our website. Follow us on social media: 

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