David Hemler, CFP®
Hmmm. Good question. And the answer is…it depends. While most of us don’t need to consult a financial therapist, many of us do have some behavioral finance issues or money biases that affect how we enjoy our financial prosperity. Sound about right? Don’t worry; you’re not alone.
As humans, we possess many characteristics that both enlighten and impact our lives. We inherit our physical characteristics, while many of our mental or emotional characteristics we pick up from our environment and upbringing. My money behaviors may have roots established when I was very young. One aspect of behavioral finance is to explore our financial views and behavior to try and understand what makes us tick, financially speaking. You may be wondering, “Does it matter?” Maybe, or maybe not.
Behavioral finance is a newer field of study and is beginning to gain some traction and media exposure. I recently spent a semester studying the subject and wanted to share some thoughts. My past education is limited in the field of psychology, so please understand my views are still developing. Research suggests as common sense does too, that we gain insight from those around us when we are young and formable. What we witness, hear, and experience shapes how we think about many subjects, well into our adult lives, including money.
I grew up in nearby Taneytown, Maryland. My parents were hardworking, everyday Americans, as were most of my friends’ parents and relatives too. I was one of five siblings, and we were, well, normal but middle to lower middle class economically speaking. Incidentally, so too were most of the families in our community. Our rented home was a three bedroom, one bath, affair. And when it came to something as simple as bathing, well, (no pun intended) even though water wasn’t trumpeted as a scarce resource by most then, we still had to conserve, i.e. more than one person shared the bath water as a routine. “Why?” Because hot water was a limited resource and taking a cold bath wasn’t much fun.
“Okay Hemler, but what does this have to do with behavioral finance?” Chances are my subconscious mind would latch onto a belief about conservation because of this experience. I could come to believe that conserving is necessary and sensible, which would manifest in my actively saving money and other resources in a natural and healthy manner. On the other hand, if a belief formed that conserving was a hard and unpleasant experience, it may have propelled me to work to my fullest, so that I never was presented with a need to conserve and could avoid the subject of conservation altogether. Not believing I would ever go without or need to save for the future, could have been influenced by an experience such as this. Psychologists refer to this as cognitive dissonance, having mental discomfort from a contradiction of beliefs, or ideas, or values.
I’m sure you’ve heard someone say, “Money doesn’t grow on trees?” A common expression I frequently heard in my youth from many adults. Of course, I knew money didn’t grow on trees but the imprinting that could have been occurring from hearing this time and time again was nonetheless real. I could be led to believe that earning money would be hard.
When I was a teenager, I had a job that paid me a fair amount for my age and the time. I made more money than my mom did when she worked the whole week at a factory. This undoubtedly influenced my early financial behavior. I didn’t save much in my early adult years because I didn’t think it was necessary. Money always seemed easy to come by in my teens. This might be an example of a money bias such as overconfidence.
Behavioral finance examines why we think the way we do about money and our financial decisions. As a financial planner, I am educated to help figure things out for my clients. Tell me your financial goal and, like any sound financial professional, I can do the necessary calculations to help you understand the arithmetic required to help you pursue your goal. But this doesn’t address the behavioral part of the equation. I may know I need to save $20,000 each year for ten years to achieve my retirement goal, but knowing the arithmetic does not drive the behavior. Behavior is action-oriented and requires me to do some things. Most of us will face money concerns in our lives, and this is often the cause of conflict among couples. Taking some time to get to know your money views and thinking about this subject can be worth a little effort.
Uncovering our money biases isn’t an easy endeavor, and the truth is, in my opinion, most of us probably never will. Things like fear and greed will drive much of our decision process when we allow it. The study of behavioral finance seeks to help us gain insight and control of our tendencies that may not be in our best interest. Pretty important stuff too, or so I think. Go forth and prosper my friend.