Chapter 2
The Psychology of Money
In this chapter, you will learn how the ways we think about money can affect us positively or negatively.
Many of our attitudes about money are formed in childhood. These attitudes affect our behavior and actions throughout our lives, and even affect the outcome of our financial future. Many people discount or underestimate the power of our money attitudes in our decision-making and planning.
We have beliefs and attitudes about everything that is important to us in life. For example, we have attitudes about politics, religion, war, marriage, and, of course, about money. How can you have an attitude about money? Well, your attitude is what money means to you. How do you feel about money? How much does money influence all of your decisions in life (not just your financial ones)?
Simply, your money attitude is your way of thinking about money. And it can affect you negatively or positively.
Glenn D. Wilson, one of Britain’s best-known psychologists, once said, “Money evokes conditioned emotional responses. People become obsessive about money—it gives them a buzz like an addiction. It has commonalities with food, which might suggest an evolutionary origin for our craving. And money is more than just a means to an end. It prompts behavior that cannot be explained by its utilitarian value. People rolling in money still seek more of it, as though they can never get enough. They will sacrifice other values such as family and friends in favor of accumulating money. They chase money for the sake of money or perhaps to keep ahead of the Joneses.”1
Money is such an important part of our lives because it affects our relationships, our career choices, our education, our families, our retirement, our charitable giving, and much more. How do you feel about money, and when you think about money what thoughts come to mind? What thoughts do you have from childhood about how money affected your home life? Did your parents argue about money? Did you feel worried about money? Fast-forward to now. Do you argue with your spouse or children about money? These are important questions to ask yourself to uncover your attitudes toward money.
For me, money attitudes were embedded in me as a young child. I can recall countless lessons that I learned while sitting at the kitchen table. My older brother Mike and I were often pretend audience members in our living room, as my father practiced his various financial presentations. Today, I’m trying to embed that same financial education and money mindset into my three children.
Your past experiences are the biggest influence on your attitude and feelings about money. Many psychologists believe your attitude is a learned behavior and that what is learned can also be unlearned. Since our psychology influences and shapes our financial situations, it’s time to get at those underlying emotional reasons that may be holding you back. Many of us get emotional about money rather than dealing with it in a realistic, unemotional manner. And we also have huge fears about money, especially when we are in the throes of managing it and investing in the stock market.
With a healthier attitude towards money, we can continue on our path to financial success and retirement readiness. Patience, persistence, and an end goal, or “vision,” will help us on our journey.
The Science of Fear and Greed
Let’s look at some of the ways emotions are processed in the brain and how those emotions can interfere with clear decision-making. We call these “cognitive and emotional biases.”
Daniel Kahneman, recipient of the Nobel Prize in Economic Sciences for his seminal work in psychology, is considered by many to be the Godfather of neuroeconomics and behavioral finance. Kahneman and collaborator Amos Tversky, a Stanford mathematical psychologist, developed many theories which identify and explain irrational human economic choices.
Cognitive Biases
Cognitive biases are tendencies in thinking that influence how we make decisions. The mind acts on perception, not reality. As a result, we tend to think the current situation will continue forever. Cognitive biases can cause us to make inaccurate judgments, decisions, and interpretations. Although it’s impossible to completely avoid cognitive biases, it is possible to understand what they are so that we can look for them when they arise and adjust our judgments as needed.
People fear a future without enough money, and what that would do to them and their family. Surprisingly, this fear can, at times, hinder someone from reaching financial goals.
Fear Bias
Example #1: Loss Aversion
In 1979, Kahneman and Tversky finalized their theory of Loss Aversion. They confirmed that, where money is concerned, we prefer avoiding losses to making gains. Put another way, the pain of losing things is usually greater than the pleasure of acquiring them. In fact, their theory concluded that investment losses have more than twice the impact of investment gains on people’s minds.
Example #2: Confirmation Bias
This is the explanation for why people tend to search for information that authenticates their own opinions, but pay no attention to information that invalidates their beliefs. For example, some people who identify most closely with conservative politics may prefer watching Fox News rather than a more liberal channel such as MSNBC. The reason for this is that each network will often confirm their viewers’ political and social point of view. Confirmation bias creates a one-sided view and can cause serious problems when investing. For example, have you noticed that as soon as you invest in a fund or buy a stock, you start looking for reasons why your decision was right? Once a fund or stock is bought, we tend to look for information that confirms the investment is a good one while ignoring information that the investment may be bad or questionable.
Greed biases, listed in the next section, are similar to fear biases in that they are rooted in specific neurological functions; the greed is not simply a hunger for money.
Greed Bias
Example #1: The House-Money Effect
This common bias is based on the premise that people are more willing to take risks with money they obtained easily or unexpectedly. For example, investors might take more risks with money they inherited or won while gambling on vacation in Las Vegas than the money they set aside from their paychecks. It is a tendency to feel like gains are “free money.” It’s what poker players call “house money.” People then abandon their traditional risk management techniques, resulting in greater risk than that with which they would otherwise feel comfortable.
Example #2: Self-Attribution
Self-attribution is the tendency for people to take credit for successful investment outcomes while blaming unsuccessful outcomes on bad luck or on external directives that they could not know or control. For example, perhaps you were fortunate enough to be one of the first private investors in Starbucks before it went public. You might say, “Look how smart I am!” However, the opposite might have happened if you were unlucky enough to have invested in Enron. You would have “excused” your subsequent losses by saying, “No one could have predicted that.”
Solutions and Help
Now that I’ve described a few investor behaviors and money attitudes, you might begin to recognize such behaviors in yourself as well as the attitudes you have that are holding you back from realizing your goals. The secret is to take control of your money by taking control of your mind. And the best way to overcome the psychological biases is to be familiar with them, be self-aware when you are feeling extreme emotions, and to have a methodical financial plan. To have a methodical plan, you have to “Start with why,” a principle of success explained in Simon Sinek’s book about why companies and people fail and/or succeed. You must “believe” in what you do and you must first know why you are doing it. We need to reflect on our beliefs and the reasons why we are going through the motions of financial or retirement planning.
What’s Ahead?
In the next chapter we will talk about how retirement may look in the 21st century, how it has changed, and why it will be different from our parents’ retirement. Pension plans are changing, the underfunding of Social Security is looming, people are living longer, and managing money today is much different than it was 30 years ago. We need to understand the reasons behind these and other changes and challenges in order to understand the why.