The Psychology of Money

Physician's Money Digest, Spring 2013, Volume 15, Issue 1

The psychology of money not only involved you, but also your relationships with others. Money is an essential aspect of working and living, and your net worth is an important number.

For instance, consider the following scenarios:

· You’re waiting to be reimbursed by an insurance company as your bills pile up.

· You purchase new technology for your practice that increases your productivity.

· The compensation system changes and you now have to “work harder” for the same money.

· You consult with a financial advisor to confirm what you knew — you don’t have enough to retire when you thought.

· You and your significant other swing from avoiding talking about money to fighting about money.

· You struggle internally about how to bring up money issues with your adult children or your aging parents.

All of these examples illustrate how money and psychology are related at work, at home and during retirement. There are three strategies to help you benefit from the science of psychology when managing your financial life:

1. Discover your life goals, first, and then your financial goals.

2. Make objective money decisions driven more by rationality than emotionality.

3. Act in ways that are aligned with your life goals, financial goals, and money decisions.

Financial Goals Follow Life Goals

The first question many prospective clients ask a financial advisor is, “What is the rate of return on your portfolios?” This is an important question. But there is more to developing a financial plan and having a financially satisfying life than chasing returns. Picture what your emotional life would be like if it is tied to the ups and downs of the market. That is not a healthy way to live.

The first question prospective clients should ask a financial advisor is, “How can I finance my life goals in a way that I can sleep at night knowing my money is secure and growing to meet my future needs?” This question does not ignore financial returns while still focusing on your life today and tomorrow.

· Your level of life and financial satisfaction.

· Your dreams and aspirations for the future.

· Your career or income earning potential for the future.

· Your specific major purchases spread over the future.

· Your anticipated transitions such as change of job or change of location.

To begin formulating your life goals and life-enhancing financial goals, challenge yourself to discover:

Money Decisions

Decisions may seem purely objective and rational, but researchers in neuroscience and behavioral finance know that we can arrive at a decision emotionally first, and then seek a cognitive explanation for the decision. This is natural. We are wired to use short cuts or what psychologists call “rules of thumb” or heuristics.

The dilemma is that these “rules of thumb” cause us to engage in biased decision making. Some of the more common biases or “rules of thumb” that we all make concerning decisions about money include the following.

Overconfidence Bias

The tendency to believe that a positive trend will continue or that your knowledge and skills give you a sustainable advantage. Research shows that this tendency actually results in greater losses when investing.

Availability Bias

The tendency to make decisions only on information that is easily available. Research shows that this tendency actually results in more myopic decisions and can even lead investors to display a home bias, which is investing in companies that are actually physically closer to their home.

Anchoring Bias:

The tendency to fixate on a specific number and evaluate progress based upon that number and ignore what may have changed. An example: You bought your home for $500,000 and today it is worth $400,000. As the seller, you are anchored on the purchase price instead of the current market value, which can cause you to hold onto the home for far too long and miss an opportunity to sell.

The first step to overcoming these biases is to recognize that they exist and that you are vulnerable to them. Even professional money managers are not immune to them. The second step is not to rush into any decision unless the situation is urgent. It is far better to be an effective financial decision maker than a quick one. The third step is to consult with others — ranging from informed colleagues to professional advisors — realizing that, at the end, it is your decision.

Financial Congruence

We are all familiar with the concept of “walking the walk.” If I followed you for a week would I know your life priorities just from watching how you spend your time, talent and treasure? The key to financial satisfaction and life satisfaction is partially about your net worth, your ability to pay bills on time, all the time, and your ability to save for the future.

1. Do my money decisions, including daily decisions, reflect my life and financial goals?

2. Are biases and relationship problems impacting how I make money decisions?

3. Do my behaviors reflect my money decisions as well as life goals?

To live a financially congruent life, ask yourself these three questions:

If you are not satisfied with your answers, put a plan of action in place to close the gap between what you intend and what you are living. Less stress is often associated with greater congruence.

Marty Martin is on the faculty at DePaul University and is a financial psychologist at Chicago-based Aequus Wealth Management, a financial planning firm specializing in helping people bounce back and thrive during times of transition. For more than 10 years, he has conducted and applied research in the psychological aspects of money and how to help individuals, couples and entrepreneurs make better financial decisions. To reach Dr. Martin, email him at marty@aequuswealth.com.