“If you knew better, you’d do better”: Understanding Financial Psychology – The Mind Behind the Money
By Krystle Gladden, Founder of Financial Fluency
People have a complex relationship with money. Each individual has a different mindset when it comes to handling personal finances – a mindset based on the person’s background, emotions, past behaviors, environment, and cognitive biases. Understanding what lies behind people’s relationships with money underpins a fascinating subject called financial psychology, located at the intersection between psychology and economics. Illuminating people’s financial psychology forms an essential step toward helping them achieve financial wellness.
This article delves into the realm of financial psychology to unpack the mind behind the money and its impact on money decisions. When people understand their emotional triggers regarding finances, they free themselves to make better-informed decisions. In other words, “If you knew better, you’d do better.”
Emotional Connections with Money
Money affects far more than just people’s bank accounts. It’s deeply intertwined with their emotions, values, and identities. One reason behind this connection is because money affects all our personal needs – not just our fundamental needs like food and shelter, but our higher-level needs like love, belonging, and self-esteem. As a result, people often make financial decisions driven by emotions like fear, greed, or guilt. Among those who have made financial mistakes in the past, the negative emotional response can get worse over time. Each new decision they make is influenced by the stress of past mistakes or fear of making another one.
Conversely, reaching a more secure financial situation reduces the stress of paying bills and making ends meet. When people know their basic needs are met and have emergency funds set aside, they feel the relief and freedom to make logical, rational financial decisions.
Background and Upbringing
People start forming their financial habits very early in life. During childhood, family dynamics and parental modeling have a strong effect on how those habits develop. Children whose parents are very frugal – pinching every penny – may adopt similar behaviors in adulthood, or they may react against those influences and become spendthrifts. Further, traumatic money experiences like bankruptcy or homelessness leave lasting imprints on a young person’s financial mindset. Whether or not people receive financial education while they’re growing up also makes a powerful difference in their financial psychology down the road.
Culture and Environment
Cultural and societal norms have a profound influence on people’s financial attitudes and behaviors as well. Some cultures view saving as a virtue, while others place high value on consumption. Environmental influences like advertising and peer behaviors shape people’s perceptions of success and financial responsibility. Social media and societal trends influence spending patterns and the images to which young people aspire. Those aspirations can lead to materialistic attitudes, overspending, and debt.
Cognitive Bias
Psychological biases develop as a result of all these influences, and those biases play an important role in people’s financial mindsets. Some common biases include overconfidence, where individuals overestimate their financial knowledge and skill; loss aversion, where the pain of losing money outweighs the pleasure of gaining it; and anchoring, where people tie money decisions to an arbitrary and illogical anchor. Such biases can lead to irrational decision-making. Recognizing your cognitive biases is essential for making sound financial choices.
Practical Strategies for Healthy Financial Psychology
Understanding your financial psychology is the first step toward taking control of your own money management life. By becoming mindful of their financial behaviors and thought patterns, people can identify and overcome detrimental habits. Setting clear, attainable goals that align with personal values provides a roadmap for saving, spending, and investment choices. Clarifying your financial mindset and working to improve it also points up areas where you might benefit from consulting a financial advisor or coach or getting more financial education.
Financial psychology represents the intersection between personal finances and the human mind. When we recognize the emotional, cultural, and cognitive factors that influence our attitudes and behaviors, we can cultivate healthier relationships with money and move closer to financial wellness. Self-reflection, systematization, and professional guidance can offer support toward this goal. Regardless how we get there, integrating psychological insights into our financial planning is key to building a secure and fulfilling financial future.
