Explore the key psychological concepts that financial advisors should understand to make you a well-rounded and impactful advisor.
Understanding the psychology of money is just as crucial as grasping complex investment strategies and market trends. Human behavior often plays a pivotal role in financial decisions, sometimes defying logic and rationality.
Financial advisors should be able to identify and talk about the unsound beliefs that can drive a person to make poor financial decisions. This blog post explores the key psychological concepts that financial advisors should understand.
Money is Emotional
We’re all wired differently. And when we hear the word money, we all have unique thoughts and emotions too. 61% of people named money a “very or somewhat significant” source of stress. “It’s understated to say that financial health affects mental and physical health and vice versa, ” said Dr. Carolyn McClanahan, founder & director of Financial Planning at Life Partners Inc. Clients may be motivated by fear, greed, envy or a desire to feel secure. It’s essential to understand your clients’ emotional relationship with money so that you can help steer clients toward more balanced and logical choices.
Money is Relative
What one person considers a lot of money; another person may consider a small amount. What’s important is not how much your clients have but how they feel about it. If they’re constantly worried about money, they’ll never be satisfied.
Money is a Tool
Money is a tool that can be used to achieve goals, not an end in itself. In a study published in the Journal of Financial Planning, individuals who leveraged a behavior-modified approach that removed emotion from their investing saw upwards of 23% higher returns over ten years. It’s important to help your clients understand that money is a means to an end, not the end itself. If they focus on accumulating money to earn money, they’ll never be satisfied.
People tend to rely too heavily on the first piece of information they receive when making a decision. This cognitive bias can impact financial decisions when clients anchor their expectations to a specific figure or value, even if it’s not the most accurate or relevant. For example, if a client tells you they want to retire with $1 million in savings, you must know that this number may anchor their thinking. You should help them adjust their expectations based on their financial situation and goals.
Loss aversion, the tendency to fear losses more than appreciating gains, can significantly impact investment decisions. This can lead to clients making negligible financial decisions, such as selling stocks at a loss to avoid future losses. Recognizing and addressing these biases can help you encourage clients to make decisions based on objective analysis rather than emotional attachment.
Humans are inherently social beings, and this extends to financial decision-making. People often follow the crowd, even when it’s not in their best interest. During market frenzies, clients might feel compelled to join in speculative investments because "everyone else is doing it." Helping clients resist the pressure of the herd and emphasizing independent research is essential for making sound financial decisions.
Delay Discounting and Long-Term Planning
The concept of delay discounting explains why individuals often prioritize immediate rewards over larger, delayed benefits. This behavior can hinder clients from adequately saving for retirement or other long-term goals. Your role is to emphasize the importance of delayed gratification and the long-term benefits of disciplined financial planning.
The Bottom Line
The psychology of money is a vast and captivating subject that profoundly impacts our financial lives. Many financial advisors now incorporate the insights gained from behavioral finance in working with their clients. Balancing financial expertise with understanding human behavior will make you a more well-rounded and impactful financial advisor.
Interested in learning more about the intersection of emotions, finance and human behavior? Tune in to episode 16 of FAST Podcast with the Founder of the Financial Dignity® Movement and Coach — Christine Luken.