Why Personal Finance Is Dependent Upon Your Behavior

Your personal financial success isn’t about your IQ or math skills, but it is driven by your behavior. The rules for personal finance success are simple. Spend less than you make. Save and invest. Don’t have bad debt.

However, forming the behavior needed to succeed is the hard part. The positive behaviors are the part where most people fail on their journey to financial freedom.

There is a huge psychological component to personal finance that you need to account for. The easiest way to keep on plan is to automate as many positive behaviors as you can. Secondly, you want to ingrain healthy money habit behaviors for all those actions that can’t be automated away.

If you focus on the big items, you can set yourself up to succeed.

What Is The Psychology of Money?

The psychology of money is the study of your behavior and relationship with money. If you know what your tendencies are when dealing with money, then you can use it to your advantage.

Are you a saver? A planner? An impromptu spender? Do you have certain vices or triggers?

By gaining an understanding of your behavior you are able to adjust them. Ultimately you want to try to get your habits to work in your favor.

How Behavior Drive Your Personal Financial Situation

People form habits through repeated behavior. But then those habits drive future behavior. The legendary coach Vince Lombardi said, “Watch your actions, they become your habits. Watch your habits, they become your character.”

For instance, someone who is going through a stressful time may start biting their nails. After a while it just becomes an automatic behavior that they do without thinking about it. Eventually, it is such an ingrained part of who they are, it becomes extremely hard to stop even when they want to.

The same feedback loop happens for all actions, including financial decisions.

Maybe you were going through a tough patch in your financial situation. To make ends meet, you started putting purchases on a credit card and were unable to pay off the balance. You got used to carrying a credit card balance. Then, even when your finances improved, you are de-sensitized to having a credit card balance. Therefore, you continue to spend and never get around to paying off the credit card.

Your behavior became a habit. And then your habit became ingrained. Even if you say you want to break it, it becomes hard to do. You keep falling back on the negative behavior.

Why Bad Personal Finance Behavior Becomes Hard To Fix

Everyday you are faced with tens of thousands of decisions. If your brain had to think about each action you took, it would be impossible to get anything done. These can be broadly categorized as 1) short-cuts, 2) reflexes, and 3) conditioning.

In order to focus on the important decisions, your brain develops short-cuts. These are rules-of-thumb and heuristics that your brain uses to make quick decisions.

For example, if you are driving a car and a ball rolls across the street in front of you. You would instinctively slow down and scan the area the ball came from looking for a child or pet chasing the ball.

If you had to think through the situation fully, by time you reached any conclusions it would be entirely too late. Instead your brain has a short-cut of “kid/pets chase balls”.

Similarly, if you touch a hot stove, you will reflexively pull your hand away.

Lastly, your brain makes connections between causes and effects. This is best known with Pavlov’s dog, the classical conditioning experiment where a scientist would ring a bell before feeding dogs. After a while, the dog linked the sound of the bell with the reward of food. Even if no food was given, when the bell rang the dog would start to salivate.

Behavior and Poor Financial Decisions

Reflexes, conditioning, and heuristics are great a lot of the time. However, the same mechanisms can result in negative behaviors.

Do you automatically stop at the drive-thru coffee every time you see it, even if you didn’t really want a coffee when you left home?

That is classical conditioning where the stimulus of seeing your favorite coffee spot and your body associates it with a reward of coffee.

Do you try to save money every month, but then never seem to have any money leftover to save after paying bills?

That is mental accounting bias, a form of heuristic. Your brain is making a short-cut in the way it is thinking about the money you get that isn’t accurate to the real world. This is especially seen after people get a bonus or windfall. They view this money as different and expendable and then go overspend it.

For example, you get a $1,000 bonus and go spend $1,200. But then when the money given to you is after-tax and you get $800 deposited into your account. Instead of being +$1,000 like you thought, you are negative $400 (spent $1,200 but only got $800 after-tax). This is often part of the ‘lottery winner’s curse’.

Do you buy scratch-off tickets every time you go inside to pay for gas?

This is a form of reflexes. You have formed the habit of paying for gas and buying lottery tickets. You do it on auto-pilot without thinking about whether you should.

However, the good news is the same behavioral mechanisms that can lead to poor personal financial decisions can be used for positive ones.

Behavior and Good Financial Decisions

One of the best things you can do is ingrain positive personal finance behaviors into your life. The opposite of the example above with someone desensitized to carrying a credit card balance is someone who always pays off their credit card statement. If you practice positive personal financial behaviors, you will develop positive habits.

Some of examples of positive behaviors for your finances include:

Automated savings:

The more you automate an action, the more likely you are to stick to it. If your company allows you to split your direct deposit into multiple accounts, deposit some into your emergency fund. If not, you can set up an automatic re-occurring transfer.

Even $50 or $100 per pay period put into a separate emergency fund savings account will add up to $1,000s in a year.

And by automating your saving, you don’t need to worry about actively remembering to do it.

401k contributions & automatic increases:

Most 401k plans come with an employer match. It is common to get a 100% match up to 4% or 50% match up to 6%. This means if you put in 4%, your company will also put in 4% (or if you put in 6%, your company will put in 3%). This is ‘free’ money. And 401k contributions are taken out of your paycheck before it goes in your checking account making money you don’t ‘miss’.

After setting up at least your employer match, you should look for automatic 401k contribution increases. Most 401k plans have the option to increase your contribution by a pre-set amount each year. This means after you get a pay raise, you will automatically contribute some of that extra into your 401k. If you choose at least a 1% increase each year, you will drastically grow your retirement fund. And by automating it, you take the emotion of the decision out of it.

Paying off credit card at end of month:

Similarly, make it a habit to always pay off your credit cards each month. The more you ingrain the behavior, the less likely you will allow yourself to have a balance that accrues interest.

After a while, it become second nature to adjust your spending to avoid having balances.

If you automated savings, you even have a back-up for when unexpected expenses pop up. This way you never have an excuse to keep a credit card balance.

Takes XX Days For A Behavior To Become A Habit

Depending on where you look, it can take 21 days, 66 days, or a range of days for a new behavior to become a habit. Depending on your personality and the action you are trying to ingrain, the period may differ. But one thing is clear, after a while a habit is formed.

There are some tricks that you can use to help the process:

• Habit Stacking – If you already have a habit, you do the new behavior at the same time. For instance, if you brush your teeth every night, then you do the new action immediately before or after you brush your teeth. By stacking the new behavior on top of your regular tooth brushing, you are more likely to stick to it.
• Calendar X trick – This is a common trick made popular by Seinfeld. You put a large calendar somewhere very visible. Every day you do the new habit, you make a big ‘X’ on the day with a red marker. After a while you have a string of ‘X’s that you don’t want to break. Seeing the calendar is a reminder to do the behavior.
• Accountability Buddy – peer pressure is impactful. Having someone else who is working on the same goal as you can be a huge help. You may be able to justify skipping actions when you only need to report to yourself. But having to check-in with someone else and tell them you didn’t follow through can be enough of a push to keep you on track.

Lastly, it is often easier to choose one small change and focus on it. There are 5 pillars of personal finance, and you can focus on one pillar at a time. Trying to change behavior across all areas at once may be overwhelming.

The Final Word

At its core, personal finance is easy. Everyone knows to spend less than they make, save, and invest in order to be successful. Most of personal finance can be captured in just 8 behaviors. The hard part is taking the proper actions.

Your behavior is what will drive your results. Having a plan and utilizing tricks to stick to the plan will allow you to find success with your personal financial journey.

Frequently Asked Questions (FAQs):