Anthony Martin, founder and CEO of Choice Mutual says: “The relationship between our mindset and how we handle money is exciting! Your beliefs, attitudes, and behaviours towards money can affect your financial health. If you take the proper steps – acquiring sound financial education, building healthy financial habits, cultivating a sense of abundance, and focusing on long-term goals – you’ll be on your way to developing a healthy relationship with money that will lead you to live your best life possible!”
Money is a crucial aspect of our business and personal lives. Indeed, every financial decision we make can significantly impact our well-being. However, despite the abundant resources and financial advice available, many people still struggle to make sound financial decisions. A study showed that 2 in 5 adults feel completely lost when it comes to managing finances. But how and why exactly do we make financial decisions? The answer lies in the psychology of money – how our mindset and beliefs about money affect and influence our financial behaviour. It is important to know that various factors, including upbringing, cultural values, and personal experiences, shape our attitudes and behaviours toward money.
This article will take a closer look at various aspects of the psychology of money and how they affect our financial decisions. By better understanding your relationship with money, you will be better positioned to make more informed and healthier financial decisions, leading to greater financial prosperity.
The mindset of scarcity and abundance
One of the fascinating concepts in the psychology of money is the idea of scarcity and abundance mindsets. So what exactly are these mindsets, and how do they affect our financial decisions? The scarcity mindset is focused on what we don’t have. Individuals with this mindset are known to fear not having enough. Such people are not too concerned with long-term thinking; they prioritize immediate needs and short-term gains.
Conversely, the abundance mindset is more concerned with what we do have. Individuals with this mindset exhibit feelings of plenty, possibility, and gratitude for what they have. They tend to be more focused on the future and long-term goals than short ones. Both scarcity and abundance mindsets impact our financial decisions in unique ways. For a better understanding, let’s look at the following scenario.
Suppose you have a scarcity mindset and experience a sudden financial windfall, such as an unexpected bonus. You may be tempted to spend the money quickly before it’s gone. The scarcity mindset causes you to prioritise immediate needs, which can provide temporary relief, but may not necessarily be a good decision considering long-term financial stability.
On the other hand, an abundance mindset will likely see you approach the same situation with a longer-term perspective. You may consider investing the money in your future, such as setting up a business or saving for retirement. While patience may be required before reaping the rewards, an abundance mindset can lead to greater financial security in the long run.
Although these mindsets exist, they are not fixed and can change over time. When you are conscious of your attitude towards money, you will be able to work towards developing a mindset that aligns with your values.
Role of emotions in financial decisions
More often than not, our financial decisions are guided by emotions rather than rational thinking. When emotions override logic, it can lead to you making poor financial choices.
One of the most prevalent emotions that impact our financial choices is fear. But what provokes this fear in us? It may result from a job termination, economic downturn, or the fear of overlooking a good investment opportunity.
When under the grip of fear, we are more prone to making impulsive judgments that we may regret later, such as selling stocks too quickly or completely avoiding investments.
Greed is another emotion that affects many of our financial decisions. There are diverse ways in which greed can arise: whether in pursuing a quick profit or undertaking excessive risk. Whenever greed emerges, it may lead you to prioritise short-term profits over long-term stability and security.
Happiness is another emotion that influences our financial decisions. When excited and optimistic about our financial future, we may overspend or take on more debt than we should. And these are some of the biggest risks to financial success.
One thing worthy of note is that not all emotions have a negative impact when it comes to making financial decisions. Emotions like gratitude or contentment can lead you to make more responsible financial choices, such as saving money or avoiding unnecessary expenses.
Jarret Austin, Owner of Bankruptcy Canada, adds,
“we must recognize the role of emotions in our financial decision-making. When you truly understand how your emotions can impact your financial mindset, you will be more aware of your biases and be able to make financial choices that will benefit you both in the short and long term.”
Power of habits in financial success
Habits are a crucial component of our daily existence, and they play an essential role in deciding if we will succeed in various aspects of our lives, such as our finances.
Regarding money, every individual has financial habits, which can either lead to financial success or failure.
There is no denying that our habits frequently impact our daily monetary decisions. For instance, an individual with a tradition of spontaneous spending may find saving money and building wealth challenging compared with someone who takes time to plan appropriately before splashing out.
So, how can you cultivate appropriate financial habits that assist you in attaining your objectives? Initially, you must understand that you cannot develop new habits overnight. It would be ideal to begin small and concentrate on developing them one at a time.
An excellent way to begin is by designing a budget and tracking your expenses to understand better where most of your money goes. If you detect that you overspend on specific things, you can find methods to mitigate this and save more money.
Subsequently, you can focus on defining financial goals. When you establish realistic and achievable goals, you will give yourself a target to strive for that aligns with your financial position and priorities. Even though you may not reach those objectives, you will still observe that you have made significant progress.
Furthermore, in addition to these habits, you should also surround yourself with positive influences that will help you stay on course toward accomplishing financial prosperity. You can do this by seeking guidance from a finance specialist, joining a financial community, or gaining valuable knowledge from financial books and blogs.
It’s never too late to start building positive financial habits – every small step counts. Remember that little drops of water will eventually make an ocean!
Influence of cognitive biases on financial decisions
Humans are subject to various cognitive biases that can easily lead us astray, especially in money matters.
Our brains use shortcuts called cognitive biases to simplify complex information. Although these shortcuts assist us in making quick decisions, they often lead to errors in judgment, causing us to make decisions that might not be the best for us.
- A prevalent cognitive bias that affects our financial decision-making is the anchoring bias. This is where we hold on tight to the first piece of information we receive, without considering whether it is accurate. For example, if you come across a sale price for an item (that is considerably lower than its original price), you may be more likely to buy it, even though it may be more expensive than similar items on the market.
- Another common cognitive bias is availability bias. This is where we tend to overestimate the likelihood of an event occurring based on the outcome of similar events. Let’s say you hear about a close friend who lost money in the crypto market. Based on that information and your availability bias, you may be less likely to invest in the crypto market, even if your chances of experiencing the same loss are much slimmer.
- Confirmation bias tends to affect our financial decision-making as well. Turning a blind eye to any information that contradicts them, individuals with this bias only seek information confirming their pre-existing beliefs. For example, if you feel good about a particular investment, you may only seek information that supports your choice while ignoring any obvious warning signs or red flags.
By understanding and acknowledging your biases, you can work to overcome them and make better decisions for your financial future.
Importance of financial education
Max Wühr, Co-Founder & CGO of FINN says,
“Our financial choices are intimately linked to our degree of financial knowledge. Through sound financial education, we may be less vulnerable to overspending, making poor investment decisions, and falling prey to scams.”
Notably, sound financial education extends far beyond grasping the fundamentals of budgeting, saving, and investing. It is also about deeply comprehending how our mentality and beliefs can affect our financial behavior – and importantly, how we can cultivate a healthy relationship with money.
When you take the time to acquire solid financial education, you will be setting yourself up to develop better financial decision-making skills and avoid common financial pitfalls.
Obsessed with finances, building tech and collaborating with other successful entrepreneurs, Anthony Martin, CEO and Founder at Choice Mutual is a nationally licensed life insurance agent with 10+ years of experience. He is an official member at Forbes Finance Council.