Most of what is written about financial planning, investing, and markets is focused on the endless number of external factors happening around us in the financial world. They focus entirely on how our financial lives are impacted by outside influences. “Bonds did this”, “stocks are doing that”, and “here’s why this is happening” or “this is what will happen next” form the basis of most things you will read. You must then digest this information and deduct how it will impact your life. The flaw in only focusing on the external variables of the financial world is it leaves you constantly reactive to things outside of your control. The world is too complex to digest an infinite number of variables and interpret them correctly all the time.
Instead, we should focus more of our time on what we can control. One way to do this is to look internally and try to better understand what is driving our decision-making when it comes to our finances. Our habits and mindset around money will have the biggest long-term effect on our financial outcomes. To do this, we must explore our habits and look for recurring patterns of behavior. Second, we must understand the basis of these habits, which are the stories we tell ourselves when it comes to money. Like most things involving psychology, the foundation of our habits and internal narratives come from early on in life- what we learned from those who raised us and our earliest experiences with money. From there we tend to build hardwired habits and tell ourselves repetitive stories without even really knowing it.
Our experiences are much more impactful than anything we are taught in school. If you were born into poverty with parents who had strict rules on any sort of spending you are going to have a different outlook than someone whose parents provided them with everything they needed and spent carelessly. We all view risk and reward through our own personal lens, which is why our personal finances can’t have ironclad rules like physics or engineering. Consider the stock market crash of 1929 and the Great Depression. We can study it in detail as much as we want, but we can’t have the visceral emotional scar tissue of those who lived through losing their entire net worth, or experienced 20% unemployment, starvation, and homelessness. These are the emotions that drive decision-making in real life.
Consider today’s environment. We are seeing the highest inflation in a generation. If you were born after 1985, you really can’t understand what sustained higher inflation can do to a household because you haven’t experienced it. As a result, any period of sustained inflation will likely impact many people’s financial picture negatively without them understanding it. In 2006 economists from the National Bureau of Economic Research went through 50 years of survey data related to consumer finances. What they found is people’s investment decisions were directly in line with the experiences they went through early in their adult life. People who grew up in a period of strong stock market returns tended to invest more of their assets in stocks. Those who saw volatility and market crashes were more risk averse. Income level, education, or financial sophistication were irrelevent. The biggest factor in financial decision-making and outcomes was the random luck of when you were born and what you experienced as a result.
Do you constantly struggle to spend within your means? Do you tend to throw your hands up with thoughts like “I’ll never get out of debt”? Maybe you have too much cash sitting in a savings account to give you a feeling of security. Perhaps you tend to actively avoid thinking about money all together because it triggers stress. These are the types of recurring thoughts and habits that are rooted in our subconscious for one reason or another. Trying to better understand the “operating system” that is our subconscious mind and how it is dictating our outcomes is essential to making better decisions. If we can understand the driving factors, then we can make changes so it works more to our advantage. That is not to say it is an easy task. It can be complex and emotional, and it is all happening entirely underneath the surface of our conscious mind without us knowing it. If we want to make better financial decisions moving forward though, we must first understand how and why we make them.
The initial reaction to this concept of the subconscious mind running the show for most people is to push back on it. We all think we are rational, logical, and that we understand what we are thinking and the reasons we make decisions. This is simply not the case though. In 2005, the National Science Foundation summarized research that showed the following:
- On average we have 12,000 to 60,000 thoughts per day
- Of those thoughts, 80% are negative, and almost all of those are recurring thoughts
- 95% of decisions are made by the subconscious mind up to seven seconds before we are consciously aware of the decision being made
This means that our conscious rational mind based in the prefrontal cortex part of our brain is in control a measly 5% of the time. The vast majority of our thoughts are reruns of limiting thoughts or beliefs and habit loops we are not entirely aware of. By acknowledging this we can cut ourselves some slack and make it easier to get to work improving our approach with money.
Before deciding on specific tactics around investment, tax-planning, or retirement strategy, your habits and beliefs with money must be well understood. Product salespeople can’t solve for behaviors (neither can software). By engaging with a fiduciary advisor who spends time asking questions, building a relationship, and understanding how you think about money, you can bring in a trusted outside perspective whose interests are aligned with yours. We all have different goals, worries, and personal histories. A good financial plan takes these into account. In order to better plan for the future, we first need to better understand our past.
Creating Hockey-Stick Style Growth By Taking The Uncomfortable Leap, Stephanie Bogan, Kitces.com
The Psychology of Money, Morgan Housel