What is Financial Psychology?

Financial psychology is the study of the mind and behavior as it relates to spending, saving, and investing decisions. Financial psychologists apply psychological theories, methods, and practices to the areas of personal finance and financial services. The field takes into account both individual differences in money-related behaviors and decisions as well as client psychology, that is, the application of psychology in the context of an individual’s relationship with a financial professional.

To understand financial psychology in the broader field of psychology, we will first consider the basic definition of psychology from the American Psychological Association (APA):

Psychology is the study of the mind and behavior. The discipline embraces all aspects of the human experience — from the functions of the brain to the actions of nations, from child development to care for the aged. In every conceivable setting from scientific research centers to mental healthcare services, “the understanding of behavior” is the enterprise of psychologists.

If we use that definition as the basis for financial psychology, it is easy to see how the various fields within psychology each contribute to the study of the mind and behavior when it comes to money.

From an individual perspective, financial psychology encompasses practices related to managing one’s financial life (that is, personal finance) and draws heavily from areas including developmental, social, cognitive, and consumer psychology. The individual side focuses on how we make decisions about saving, spending, and investing. As an example, consider the way you made your last significant financial decision, perhaps the purchase of a car or home. From a purely economic perspective, there is a “right” answer in terms of the most advantageous financial response to your decision. This economic “right answer” is not always chosen. Why? We are influenced into decisions by others (social psychology), we have expectations or schemas for what we want our lives to look like today (developmental psychology), and we have biases in our decision making (cognitive psychology). All of these psychological variables (and many more!) may lead us away from the most financially advantageous answer when considering how we spend our money.

From a client-advisor standpoint, financial psychology includes aspects of the academic fields of financial planning, therapy, counseling, and coaching. The CFP Board defines client psychology as the biases, behaviors, and perceptions that impact client decision-making and well-being (CFP Board & Chaffin, 2018). We view client psychology through the lens of a client-advisor relationship. As a financial planner, for example, client psychology permeates each interaction with a client. Consider how you establish rapport with a client who may be unwilling to take advice (client personality), help a client overcome biases in decision-making that lead to negative investing outcomes (cognitive psychology), and address the needs of a client in the later stages of life (developmental psychology). Each of these challenges requires considering how the advisor and the client thinks, feels, and behaves in the context of the financial planning relationship.

At DataPoints, we focus primarily on the areas within psychology known as personality and individual differences and psychometrics as we create instruments (tests) designed to understand an individual’s characteristics and patterns of behaviors when it comes to spending, saving, and investing. By measuring characteristics that are relatively stable over time, we can anticipate how a client might make a decision in the future. Armed with this information, individuals and advisors can enhance future financial decision-making based on a scientific understanding of financial psychology.

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