Living Life in the Hot and Cold State

Neuropsychology contributes to our understanding of why we make the economic decisions we do.

Hot and cold state science explains why we often change decisions after we think about them.

There was a customer who spent $17,000 in one day. The next day, she came back with a note from her therapist that said she was a shopping addict and needed to return the items.” (From Crazy Stories)

Though unbelievable, this really happens. During a writing class I attended at the New School in New York City, a student in her late 20s, pretty and slender, related a similar story.

“On the weekends, I go to department stores and dress shops that have high end clothing I like. I’ll purchase what suits me with my credit card. The next day, a Sunday or Monday, I take the items back. This is why.

When I purchase the clothing initially I am happy. But, later as the day progresses, I begin to think about how much money they cost and if I really need them. Then, any benefit that I saw for myself originally either vanishes or is greatly diminished. Therefore, I return the clothes to the store the day after I purchased them. Taking them back seems like a small price to pay for the pleasure I received when I purchased them.”

Like my story “The Delay That Satisfies: How to Be Happy by Not Buying Things You Don't Need” this working girl’s revelation rings a bell in the human psyche. It is based on what we now know about deep-seated human behavior. Natalie Denburg, PhD, sent me the information below from a colleague of hers that is insightful regarding these stories.

In the phenomenon…referred to, I think in the throes of an auction or a 'buying frenzy', one is a hot state and focuses on all the good things about the product one is contemplating purchasing, and perhaps ignore the negative aspects. But arousal is exhausting and cannot be sustained indefinitely. So, a delay makes the arousal die down and the resulting cold state assesses the product more even-handedly with negative aspects also becoming part of the mental construal of the item.”

Interestingly, this hot and cold state science applies not just to shopping for things we don’t need (which some might consider a frivolous application), but also to more serious concerns such as investment decisions.

For example, it is commonly said that annuities are sold, not purchased. The meaning of this is that often the sale of this product benefits the seller more than the buyer. That means the investment advisor or insurance salesman or equivalent who promotes the product makes it sufficiently attractive in a sales pitch for the potential client to want to purchase it. During this promotion, the client is in the “hot” or enthusiastic state when she buys the product. It is only later in the “cold” state that she recognizes the downside of the annuity that was sold to her; she likely wouldn’t have purchased it had she taken time to explore the downside.

My take on “Hot-Cold” states is that awareness of the concept is crucial when making important investment decisions. It promotes delaying judgements that don’t have to be decided urgently. Then, all information regarding the choice can be gathered, negative as well as positive. When examined under such a spotlight, what is best for the decision-maker often looks different. Facts, rather than hope and fantasy that a salesperson provides or she herself imagines, force the buyer to re-think. It is only then that she can protect her own best interests and be happier as a result. This concept also applies to those who want to be happy by not buying what they don’t need.

For More:

The Next Best Thing: Complex Securities? Annuities dissected.

Ask the Expert ~ Annuities vs. Municipal Bonds Please see my answer below to a physician who asks:

Many companies have been trying to sell me annuities. I have about $2 million in stocks and mutual funds and around $800,000 in municipal bonds. I understand municipal bonds and have been happy with the returns. The question is should I be diversifying my portfolio with an annuity and if so which type?”

My answer:

Annuities are like butter. They seem tasty, but can be hard on the participant’s financial health. For example, high up-front loads and fees diminish any annuity profit. In addition, whether the money is returned at all depends on the solvency of the company that guarantees them. Think AIG. Lastly, annuity income is taxed at the highest tax rate, not the more favorable 15% for capital gains that is currently assessed. You are wary and rightfully so. This may be why you stated your question thus, “Many companies have been trying to sell me annuities.” Interestingly enough, your sentence supports the common wisdom that annuities are sold, not bought. By this I mean that most people wouldn’t buy one unless a good salesman was pointing out the advantages, often omitting the downside. If you feel comfortable with municipal bonds, they sound right for you. Diversifying your stock portfolio means practicing asset allocation, rather than replacing exiting stock with that in an annuity.”

This information and content is offered for informative and educational purposes only. The author is not acting as a Registered Investment Advisor, Investment Counsel, Tax Advisor, or Legal Advisor.