What is The Psychology of Financial Planning?

What is the psychology of financial planning?

On March 30th, the CFP Board announced changes to their Principal Knowledge Topics for educational programs for those seeking or with the Certified Financial Planner (CFP) designation. This change includes a new section representing 7% of the educational component, entitled “The Psychology of Financial Planning.” For those of us at DataPoints who have been writing about financial psychology and the psychology of building wealth for quite some time, we are delighted to hear that financial planners will have a basic understanding of how their clients relate to money from a psychological perspective. The change begs the question, though: what is the financial planning “psychology?” What are the components that make up the CFP Board’s latest changes? To learn more about these changes, we created an overview video here. I’ve shared more insights on the six areas that make up the new financial psychology topics below:

Psychology of Financial Planning: Six Areas

  1. Client and planner attitudes, values, biases – This is the individual differences side of financial planning, focusing on the characteristics that make the client unique, as well as the personality of the planner. This area is quite broad (or should be quite broad). It encompasses personality, interests, values, goals, attitudes, and other psychological characteristics that impact decisions related to spending, saving, and investing. In Industrial Psychology and the field of psychometrics, specifically, a great deal of time is spent understanding individual differences – how to measure them, how these differences can predict outcomes, and how to make decisions about individuals based on those characteristics. We’ve been using this same approach at DataPoints to help advisors understand client characteristics. For advisors wanting to understand their own unique approach to working with clients, consider taking our financial guide assessment.
  2. Behavioral financeBehavioral finance refers to psychological influences on financial decision-making (at the individual level) related to fluctuations in market value (at a broader level). Planners who can understand and explain changes in the market based on psychology will have the advantage of helping clients understand market phenomena (such as how the Game Stop short squeeze attracted so many investors).
  3. Sources of money conflict – Disagreements over financial matters affect the quality of relationships. Identifying where these conflicts may appear in advance and being able to serve as a guide through potential disagreements can help a planner when working with couples or families. One way our advisors use assessments is to identify potential money conflicts in advance of working with couples. This insight gives the planner a way to proactively address each household member related to their unique money attitudes.
  4. Principles of counselingMoney can be an emotional topic, particularly for clients who may have had unique experiences with money while growing up. Planners who have a basic understanding of counseling principles and ethics will be better prepared to address emotions related to finances or clients in distress. Related to point #6 below, planners will also be prepared to help the client by recommending a financial therapist or other professional if the planner finds that the emotions or issues are beyond her area of expertise.
  5. General principles of effective communication – In any relationship, effective communication is critical. Using principles of both research-based and practice-based principles from psychology, planners can improve how they listen to clients as well as how they ask questions that can ultimately guide their counsel, plans, and advice. Communication Essentials for Financial Planners is a great resource for understanding communication in a financial planning context (also by the CFP Board).
  6. Crisis events with severe consequences – Planners are often involved during client life changes. We often share with advisors that any critical life incident can impact the client in unpredictable ways. In some cases, a significant job loss or a spouse’s death can alter a client’s personality. Understanding the potential impact of these events on a client’s overall well-being can ensure the planner is demonstrating empathy during such periods in a client’s life. It can also ensure the planner knows when it may be necessary to involve another professional to help the client manage such events.

The Winner? The Client

Ultimately, working with a financial planner who has a financial psychology background can only serve to help clients. The way clients decide about spending, saving, and investing can be guided by a well-designed financial plan. Still, there are clear relationships between clients’ personalities and financial decisions. In other words, a client’s money mindset can lead to ill-advised decisions, even when a plan is in place. Financial planners who a) understand the client’s personality, b) are armed with effective communication, counseling, and crisis management techniques, and c) can anticipate potential money conflicts will be in the best positions to establish long-term and successful relationships with a client. For clients, working with an advisor who can help them avoid behavioral pitfalls will ensure they achieve their long-term financial goals.

At DataPoints, we support planners who seek to apply financial psychology within their practices by using our assessments, continuing education, and research. While the CFP Board changes will undoubtedly be difficult on the programs supporting planners’ education, the winner with these changes is the client.

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