As often is the case, many of us set financial resolutions at the beginning of the new year. Setting them is the easier bit, achieving them takes some perseverance.
The hurdle in achieving our financial goals is sometimes more a psychological one than it is a practical one.
Below are some insights from a book I have been reading, The Psychology of Money by Morgan Housel. I hope it provides some awareness into the factors that influence one’s decision-making process when it comes to money, and how, by being aware of which of our life experiences have shaped our views on money, we can begin to make better financial decisions.
“Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.”
In other words, your personal experience with money is extremely unique. And how you think the world works is primarily because of the experiences you have had with money.
Your personal experiences include: your parents, their income and values, the part of the world you grew up in, the economic climate you lived through, the job market and the different incentives and degrees of luck you experienced.
Second-hand learnings involve lessons learnt from books, videos, financial advisers, the news, workshops and so on.
Research indicates that when it comes to managing your money, what you have experienced is more compelling than what you have learnt second-hand. People should make investment decisions based on their goals, their circumstances, and the characteristics of the investment options available to them. But that is not what people do. Research found that investment decisions are heavily anchored to the experiences those investors had, especially experiences in their young adult life. It suggests that a person’s willingness to bear risk, for example, depends on personal history. Not intelligence or education.
If you grew up when the stock market was strong, you are likely to invest more of your money in stocks later in life. If you grew up during the Great Depression and witnessed your parents lose their savings, you would probably be more wary of stocks later in life. If you grew up and experienced high levels of inflation, you would probably invest into growth assets later in life and not in bonds or savings accounts. If you grew up in a country or a family where resources were in short supply, you would possibly be more frugal with your money as an adult. If your parents were wealthy, and you had an abundance of resources while growing up, you are likely to take on more investment risk and may struggle to exercise discipline when managing your finances and spending patterns.
So, the way you spend your money, extravagantly or frugally; the way you prefer to invest, cautiously or aggressively; how much you worry or don’t worry about your finances; the way you prioritise money in your life; how you value or do not value saving for retirement; how you value or do not value life insurance; how you teach your children about money; how your partner’s spending patterns affect you, and the list goes on – all of this is often based on our sub-conscious mind, based on our personal experiences with money and how those experiences wired our brains.
You could read about the Great Depression, but you won’t have the emotional scars of those who actually lived it. You could read Warren Buffett’s money lessons, but you may still struggle to put them into practice. The problem is that no amount of studying can genuinely recreate the power of fear, or uncertainty, or discipline, or boldness, or fearlessness when it comes to money.
I found this highly insightful, especially when reflecting on my own financial planning. When advising clients on financial planning, I base my advice on the education I have received and the knowledge I have acquired on the subject. But when managing my own finances, I often don’t stick to those well-proven methods and lessons. I sometimes manage it based more on my personal experiences with money and less on the education and knowledge I have acquired.
The challenge for us all is to be aware of how our personal experiences have shaped our views on money. And how those views often dictate the way in which we manage our money. As far as possible, we should base our financial decisions on our objectives, our circumstances and what expert knowledge suggests, and not let behavioural biases influence us into making sub-par financial decisions.
Munaf Mukadam, CFP®
Gradidge Mahura Investments