Our financial journeys are unique to our hopes and dreams in life and those of our family. But, how we interact with and feel about money is just as important and varied. The psychology of money should drive the how and why we manage our finances. Daniel Eck, MD, EY Personal Finance, outlines the importance of soft-skills training and shares various examples of psychology in the financial planning process.
When I was studying for the Certified Financial Plannerâ„¢ certification in the nineties, an instructor posed this question in one of my classes: if a client were to ask whether they should pay off their mortgage before they retire, how would you answer?
The students took turns giving scholarly financial analyses. But no one offered what the instructor cited as the correct answer: the planner would need to ask the client, what do you want to do? Math can provide an easy solution to whether paying off a mortgage early makes financial sense. However, focusing exclusively on numbers ignores the issue of how much importance the person assigns to being debt-free in retirement.
Personalized Financial Wellness
To achieve optimal effectiveness, a financial wellness effort at any workplace must be tailored to each employee and oriented toward delving into the psychology behind the person’s approach to finances. What works best is a multifaceted program that merges traditional financial guidance with behavioral finance concepts, the study of how psychological influences and biases drive decisions about money and investing.Â
It should come as no surprise that money is a significant cause of stress for Americans. Among adults surveyedOpens a new window in 2021 by the American Psychological Association, 61% named money as a “very or somewhat significant†source of their stress. Ameliorating employees’ financial worries can increase workplace productivity and positively impact the employer’s bottom line.
Fintech and digital-only tools are limited in terms of their benefit to employees who need greater financial wellness and reduced stress. At the heart of any well-rounded financial planning service should be access to planners who can explore the mental, emotional and family dynamics that form the basis for the employee’s financial decision-making.
See More: AssetTech: An Emerging Pillar in FinTech
The Person in Personal Finance
Psychology in financial planning gained new prominence in 2021 when the Certified Financial Planner Board of Standards (the CFP Board) added it as a topic in its certification exam. According to the BoardOpens a new window , the matter requires “knowledge of client and planner attitudes, values and biases; behavioral finance; sources of money conflict; principles of counseling; general principles of effective communication; and crisis events with severe consequences.â€
In conversations with a client, the planner must be able to do all these things: communicate effectively, listen to understand, and build a relationship over time. At EY, our planners go through soft-skills training to strengthen such capabilities.Â
Tools to Help the Planning Process
The marketplace is packed with vendors that include direct services, financial accounts, digital-only planning and direct access to financial planning professionals. Some are available individually, while others are designed as workplace, employer-provided financial wellness offerings. In the end, the best approach is often some mix of these: Online projection tools, discounted student loans, a budgeting app, tax prep services and, ultimately, direct access to financial planners to bring everything together and talk through the emotional side of the planning equation.Â
On a personal level, individuals should always challenge their financial decisions and know where they may be vulnerable. Maintain a list of online subscriptions (streaming, etc.) and review periodically, avoid impulse spending and the buy-it-now option on shopping sites, don’t let sales lead to overspending, develop a plan for when to use or avoid debt, review insurance coverages and find a workable way to budget and review spending regularly.
Examples of Psychology in Financial Planning
There’s a lot behind an employee saying they want to retire. The planner needs to explore the thinking behind the goal. When a client puts in a new request for guidance on retirement planning, the planner should begin by asking the person to elaborate on their vision for retirement. If the person is married or partnered, the planner should inquire about the couple’s shared vision. Will the person or couple be able to fill all that newly found free time with worthwhile activities? How will they prepare for a shift from earning to spending? Where will they choose to live, and why? And if two spouses or partners are not in sync about such issues, what adjustments could be made to bring the couple to terms? In addition to being about numbers, retirement planning must address each client’s hopes for – and any concerns about – life in retirement. Ultimately, how these hopes and concerns get addressed will drive the cost of retirement.  Â
Life can burden us with faults that set up roadblocks to financial wellness. Procrastination, overconfidence, fear, regret and social comparisons are among the behavioral factors that can lead to money missteps. Also, our minds can play tricks on us when it comes to money. We spend more using a credit card because we feel less pain than if we were to hand over cash. Sale prices cause us to make too many purely discretionary purchases. We focus too much on the short term and miss the bigger picture. These lapses can lead to anxiety, cash flow issues and a lack of progress in achieving goals. A planner should be able to identify and talk about the unsound beliefs that can drive a person to make poor decisions about finances.Â
In times of market volatility, a planner may need to calm the nerves of panicked investors by helping them keep their eye on the long term. At EY, we’ve taken phone calls from people whose financial troubles have led them to extreme anxiety, a sense of helplessness or worse. Only after addressing these emotions will we turn to the individual’s financial concerns.
Planning Forward
COVID-19 has been a catalyst for calls from people who feel isolated and uncertain about their future. They want to work on things they have some control over, including their finances. Although most financial planning client cases do not reach crisis level, the planner needs to be prepared for such a potentiality. Also, all planners need coaching on helping people cope with the more common, day-to-day stress of finances.
A focus on the psychology of financial planning should drive how and why planners “crunch the numbers†in a personal financial plan. To the client, the planner should be a trusted person to talk to, a shoulder to cry on when needed and a voice of proficiency, reason and calm.
Do you think psychology plays an active role in financial planning and should be paid closer attention to? Share your thoughts with us on LinkedInOpens a new window , TwitterOpens a new window , or FacebookOpens a new window . We’d love to hear from you!