The creation of wealth and achieving financial health involves more than data driven spreadsheets. There are behavioral risks along the path of wealth creation that can impact both those who have already successfully accumulated wealth as well as those aspiring to increase their personal net worth.
Wealth is often created or destroyed based on our behaviors and human behavior is anything but simple. Our financial behaviors are rooted in our past experiences, our mindset and our beliefs about money, which can lead to irrational money decisions based on emotional associations related to money. We often have factors working against us when it comes to making sound decisions related to earning, saving, spending, investing, and staying the course toward financial independence as well as maintaining and passing on wealth once it is achieved.
The Cognitive Influence
In recent years, psychologists have mined a variety of sources in researching the cognitive processes that influence financial decision-making. Due to advances in neuroscience, specifically neuroeconomics, researchers are now able to watch brain function in real time, providing us with a better understanding of how people make decisions and what drives their behavior. We now understand the financial decision-making process more than ever before.
Research has shown that financial decisions are made by the part of our brain that is little influenced by traditional, data heavy, logic focused methods. As much as we want to believe we are, of course, making decisions based on data and intellect, it is actually the emotional part of our brain, known as the limbic brain, that leads our decision making. The limbic brain prefers narratives and imagery. When faced with two choices—one with an immediate or short-term reward and another that will delay gratification over the long-term and reward our future self—our brains are wired to choose the former. The limbic brain also feels the pain of loss more acutely than the joy of an equivalent gain. Understanding and incorporating how the brain influences our financial decisions can minimize behavioral risks and increase the possibility of wealth creation and sustainability.
Our Personal Histories
It is clear that our past experiences shape what we perceive and feel about money. These beliefs, known as money scripts, have been shown to have direct links to financial outcomes including income, net worth and financial behaviors. For example, if our parents grew up during the Great Depression, we may have learned frugal habits and salient anxieties about money that shaped our lives and the lives of our children. Or, if we were raised in a household where money was a taboo topic, we may later have a hard time negotiating in the workforce or talking to our spouse about family finances. Left unexamined, these experiences can permanently and often negatively impact financial beliefs and behaviors.
Also See Northstar Related Article: The ABCs of Behavioral Biases: Overconfidence, Pattern Recognition, and Recency
- Our Ancestors: Our hunter-gatherer and small tribe ancestors had no need to save money or invest for their future—their lives were at stake daily and life span was short. Food was collected and consumed and the future was always uncertain. Also, they were at risk if they did something that jeopardized their place in the tribe. Most of what we are asked to do in terms of our present-day financial lives goes against our brain's evolutionary programming. Quite literally, we were not designed to instinctually make the types of long-term decisions required to delay gratification, like saving for the future.
- Propensity to Avoid Pain at All Costs: As a survival technique, our brains have a bias against pain and will do whatever it can to avoid it. One way our evolutionary brain programming is relevant in a financial context is how we are driven to stay within our own financial comfort zones in an effort to avoid discomfort and continue with our comfortable sense of belonging. This is especially true when our status suddenly changes in a significant way. An example of this is when inheritors or lottery winners automatically sabotage their newfound wealth, experiencing an uncomfortable level of stress which results in subconscious overspending setting them back to their previous status quo.
However, these predispositions do not mean we are destined to struggle or that all is hope lost. It simply means we need to explore our attitudes towards money and evaluate how they influence our propensity for risk. Luckily, there is growing evidence of the impact of practical "nudges" toward improved financial decisions.
How Do We Help Ourselves Make Better Decisions?
As illustrated, simply having information on wise money management and investing does not typically give us everything we need in the area of wealth creation. There are psychological factors working against our ability to make rational financial decisions. We need to establish systems and habits that will complement our financial success behaviors while reconciling our thinking and behaviors that may lead us off track.
- Identify financial beliefs and behaviors that move us toward financial success or are likely to adversely impact financial health. Establish workarounds, where needed, to improve outcomes such as automation and accountability.
- Visualize your financial goals in detail. You may even wish to create visual images of these goals. If saving for retirement is a goal you are working toward, think about what retirement means to you. In detail, picture what you are doing, where you are, who you are with, and how you feel.
- Overcome resistance to change, and take positive actions. Begin to focus on process over outcomes. Recognize that wealth creation is a process and one that can be fulfilling if done with purpose. One way to do this is to identify our core values and how our savings and spending goals align with these values.
- Have an Ally: Since a lot of what drives our financial decisions is automatic and our emotions are so prevalent in the decision-making process, it is often important to have someone on our side to be an ally and thinking partner on this path. An ally who can help us create and execute on our vision for our life. Filtered information is all around us, and not seeing other’s missteps and hard work can sometimes make us feel we are missing out on a quick and easy solution that may cause us to jeopardize our plans. Having an objective opinion about our financial picture can help us to not only make more informed decisions about our future, but also keep us on track when we falter.
Changing our financial outcomes often requires new approaches and beliefs. Financial success requires knowledge and awareness, vision, setting of goals and careful planning, systems and discipline, and maintaining the proper mindset to override our impulses and proclivities to make fiscally sound decisions. This intentional path toward achieving our financial goals helps us lead a full and satisfying life and be better equipped to maintain financial success after it is achieved.
At Northstar, we are specifically trained to help individuals with the personal side of money as well as the technical aspects of wealth creation with the goal of enhancing your overall financial well-being. As a Certified Financial Behavior Specialist® (FBS®), I apply my knowledge of wealth psychology to help individuals improve their relationship with money and build stronger financial habits to carry them successfully in the direction of their lifelong goals. If you think this type of expertise could benefit you, we encourage you to Schedule a Call with one of our advisors when you’re ready. We look forward to meeting you.