The Psychological Side of Managing Wealth

Knowledge of the market and the economic landscape is vital for managing your money. But the emotional aspect of wealth planning can be equally powerful. How we think about money shapes the way we spend, save and invest. To build a well-rounded financial plan, it’s key to understand how your psychology may affect your money decisions.

Let’s dive into the psychological side of effective personal wealth management below.

Unpacking money scripts

Have you ever wondered where people’s attitudes about money come from? Financial psychologists coined the term “money script” in 2011 to refer to the underlying beliefs about money that shape a person’s behaviors. Typically, messages and experiences passed down by your family and from your environment determine how you see money.  

There are four main scripts. Identifying the one that resonates with you can help you stop potentially harmful tendencies early and build positive habits moving forward.

1. Money Avoidant

The Money Avoidant script links money with greed and ill intentions. People with this attitude might view wealth as somewhat immoral or feel guilty for wanting money. Guilt or discomfort with money also makes saving and investing a challenge. Money avoidance often leads to ignoring investment-growth opportunities or giving a lot away.

2. Money Worship

The Money Worship script actually flips the money-avoidant script by celebrating money as the ultimate path to happiness. People who follow the Money Worship script might spend more than they can afford on expensive trips and the latest gadgets without ever feeling fully satisfied. This can lead to a cycle of overspending and risky attempts to get wealth quickly.    

3. Money Status

People with the Money Status script tend to tie their entire self-worth to money. The more money they have, the better they feel about themselves. On the flip side, financial troubles may cause them intense shame. This might lead people with the Money Status script to keep their finances secret from friends and family during difficult times, which can make recovering a financial loss that much more challenging. That’s because a support network that offers resources and valuable advice can make the road to recovery much easier.

4. Money Vigilant

The Money Vigilant script typically leads people to have attentive financial habits with an emphasis on saving. If you check your investments, asset and bank accounts daily, or even multiple times a day, you may be following the Money Vigilant script. While some anxiety is normal when it comes to money, being overanxious about risk may keep you from making high-reward investments, and it could also make simply enjoying your wealth difficult.

Understanding cognitive biases

A cognitive bias is when you make an error in critical decision-making based on your past experiences. Certain biases can be especially troublesome for financial management.

Overconfidence bias

While confidence can be valuable, overconfidence can cause recklessness. When it comes to financial management, an overconfidence bias can lead to:

• Making impulsive, risky investment decisions
• Trusting gut feelings over market research and expertise
• Trading stocks too often, which can lead to diminished returns due to more fees, taxes and market timing.

Loss aversion bias

Loss aversion involves making decisions solely to avoid the pain of losing money. The loss aversion bias tends to have two drawbacks in financial decision-making:

• Missing out on valuable opportunities that may require some risk, like investing in high-reward stocks;
• Quickly buying risky investments to try to earn back money after a loss.

Confirmation bias

Confirmation bias is our tendency to stick with our existing beliefs, looking for data that supports them, and ignoring data that contradicts them. Confirmation bias may lead to these outcomes when managing finances:

• Refusing to let go of a stock that keeps performing poorly because you feel an emotional attachment to it and are expecting it to recover
• Investing in a declining sector simply because you associate it with a previous boom
• Trusting anecdotes, like success stories from friends who invested in a particular technology or real estate, for example, over differing expert guidance

Using wealth psychology to your advantage

Once you identify potential pitfalls in your financial judgment, like your own money scripts and cognitive biases, you can begin the work of overcoming them. Financial advisors can help you navigate how these psychological factors influence your choices and can offer clear wealth management strategies that align closely with your long-term financial goals.

Sources:

https://moneysense.ca/columns/a-rich-life/what-are-money-scripts/
https://neurolaunch.com/psychology-of-wealth/
https://health.clevelandclinic.org/cognitive-bias
https://neurolaunch.com/investment-model-psychology/

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