The Psychology of Money – How Our Behavior Impacts Financial Decisions

The Psychology of Money – How Our Behavior Impacts Financial Decisions

An important first step to developing a healthy relationship with money begins with self-awareness. Understanding that emotions may drive unhelpful choices such as avoiding debt or selling investments during market declines will enable you to make more rational choices when managing finances.

Behavioral economics disproves the assumption that financial decisions can only ever be made rationally using spreadsheets and mathematical models. Instead, emotions and family history often play a part in our choices.

1. Emotions

Even the most rational investors are subject to emotional influence when making financial decisions. Fear and greed, in particular, can override our cognition and prompt us to make choices that go against our best interests.

Children often form their ideas about money through observation of parents or other role models; we may follow their spending and saving patterns or rebel against them altogether.

Fear, optimism bias, loss aversion and status quo bias are powerful emotions which can drive people to follow the herd even when it doesn’t align with their best interests. Understanding these forces of nature will allow you to avoid their harmful side-effects.

2. Self-Affirmation

Folk wisdom indicates that people tend to prefer concrete information when making decisions, opting for more secure outcomes over potential larger gains. This preference for certainty, from risk reduction to complete uncertainty, can be seen across many contexts such as investment, health and interpersonal relations decisions.

After being assigned the power manipulation conditions, participants were randomly assigned either to a self-affirmation condition (in which they wrote about why their top-ranked value was important) or no-affirmation control condition and completed a color-word Stroop task. We found that low-power participants who had an opportunity to affirm themselves demonstrated increased inhibitory control capabilities than those in no-affirmation condition – suggesting that improving efficacious self-view might alleviate negative repercussions associated with lacking power while helping individuals reach their goals more successfully.

3. Self-Destruction

At worst, financial trauma can trigger self-destructive behaviors with long-term implications – from mental health problems and strain on relationships to substance misuse or overspending or gambling issues.

One telltale sign of financial trauma is an obsessive preoccupation with finances, such as constant anxiety or excessive thinking about it. Individuals struggling with this problem may also avoid reviewing their finances, paying their bills and having conversations about money issues.

Herd behavior, the tendency to follow others’ decisions based on perceived social approval, can often cause people to make poor investment decisions and lead them to queue up for food trucks in line. Herd behavior also plays a factor when investing in stocks which may lead to market bubbles or lead to poor returns for investors.

4. Social Influence

People seeking acceptance in social settings may spend beyond their means in an attempt to fit in and avoid social rejection, while seeing friends on social media purchasing trendy clothing and accessories can cause FOMO (fear of missing out).

Researchers using social learning theory discovered that adolescents acquire their financial behavior and knowledge both from their parents and peers, but parents play a particularly pivotal role when it comes to shaping consumer behaviour and financial literacy among their offspring from birth through adolescence.

However, the findings also demonstrated that people’s ability to control their own behavior is an integral component of saving behavior. Indeed, self-control moderated the relationship between parental and peer influences on savings behavior and savings behavior. Therefore, financial literacy must be established.

5. Ego

Your Ego is the part of your personality that controls and channels all preconscious, conscious and unconscious impulses into conscious action. It serves as a powerful ally when dealing with conflicting demands – helping bring out your best performance while potentially leading to irrational decisions if left unchecked.

Success, fame and influence can easily cause your ego to expand and you may start feeling entitled to special treatment and benefits that other don’t receive – which could put your organization’s future in jeopardy if you lead it.

Financial decisions aren’t made solely on spreadsheets; rather they can often be made over dinner or at meetings where different factors such as family history, unique perspectives on life, emotions and marketing incentives all come into play. Being aware of how each factor impacts you is key to becoming financially secure.