Emotional Money: The Psychology of Proper Money Management

Nearly 2/3 of Americans rate money and work as significant sources of stress in their lives, according to the American Psychological Association.

And because money is such a common source of stress, as well as a difficult or uncomfortable topic for many to discuss, we often tend to minimize the stress by avoiding consciously thinking of how we use money. (Just think about all of the cash-free forms of payment people use today). 

But people who don’t retain at least some awareness of their spending may subconsciously base their money decisions on other people's behavior, instead of consciously making choices based on their own personal values and priorities.

Hi, my name is John Gigliello, and I am a CERTIFIED FINANCIAL PLANNER™ with the Albany Financial Group and you are listening to Invest in Knowledge, a podcast about all things financial. 

Happy New Year everyone and welcome to 2022!

As a financial planner, my goal is to educate my clients and listeners of this podcast, so that YOU can take control of your financial future.  My Mission Statement is simple: “Helping clients to live their lives by design and not by default”

You may be wondering, "Why is a financial professional talking about psychology and conscious and subconscious ways of thinking?”  Well as it turns out, there is a lot of psychology in how we make, save and spend money.

The lack of spending awareness can have a huge impact on your finances in both a short and long-term way.  What I’m about to present in this podcast could help you to make more mindful spending decisions and help ease the stress of managing your money.  

Now, a lot of what I’m going to discuss during the first part of this podcast is taken from an article written by Derek Hagen, Founder of Money Health Solutions, a financial therapy and life planning firm.  He discusses how folks can develop a Financial Purpose Statement to use that helps them examine their relationship with money and their most meaningful goals.

A  person who pursues goals and makes financial decisions that are based on other peoples' values, instead of acting on their own values, can result in living a life that the person may think they're supposed to live (as determined by others), rather than one that would actually be more likely to make them happy.

The number one regret for most people who are close to death is that they’ve lived a life that someone else wanted them to live, instead of the life they wanted to live. 

Transcript

Nearly 2/3 of Americans rate money and work as significant sources of stress in their lives, according to the American Psychological Association.

And because money is such a common source of stress, as well as a difficult or uncomfortable topic for many to discuss, we often tend to minimize the stress by avoiding consciously thinking of how we use money. (Just think about all of the cash-free forms of payment people use today). 

But people who don’t retain at least some awareness of their spending may subconsciously base their money decisions on other people's behavior, instead of consciously making choices based on their own personal values and priorities.

Hi, my name is John Gigliello, and I am a CERTIFIED FINANCIAL PLANNER™ with the Albany Financial Group and you are listening to Invest in Knowledge, a podcast about all things financial. 

Happy New Year everyone and welcome to 2022!

As a financial planner, my goal is to educate my clients and listeners of this podcast, so that YOU can take control of your financial future.  My Mission Statement is simple: “Helping clients to live their lives by design and not by default”

You may be wondering, "Why is a financial professional talking about psychology and conscious and subconscious ways of thinking?”  Well as it turns out, there is a lot of psychology in how we make, save and spend money.

The lack of spending awareness can have a huge impact on your finances in both a short and long-term way.  What I’m about to present in this podcast could help you to make more mindful spending decisions and help ease the stress of managing your money.  

Now, a lot of what I’m going to discuss during the first part of this podcast is taken from an article written by Derek Hagen, Founder of Money Health Solutions, a financial therapy and life planning firm.  He discusses how folks can develop a Financial Purpose Statement to use that helps them examine their relationship with money and their most meaningful goals.

What I would like to key in on is the actual stress of managing money, a stress that we all feel at one time or another.  

Now, Hagen feels that modern payment systems have made it easier to spend without intention.  He says that the "pain of paying” refers to the discomfort or displeasure we tend to feel when we spend money, as we can associate the act of spending with the idea that we are losing something valuable, even though we are (hopefully) getting something equivalent in value in return.

For example, when we use cash, we must physically count the amount of money needed for the transaction, and then actually hand it over to someone, which makes us very conscious not just of the fact that we are spending money, but also of exactly how much we are parting with. And because of this heightened awareness of our spending, we experience the pain of paying more so than with other forms of payment. The higher the transaction amount, the more severe the pain of paying we might experience.

Similarly, when we write a check (or, rather, when we used to write checks), we have to write the amount of the transaction at least twice – once in numbers, and then again spelled out in words. And those who still balance their checkbook will write it a third time in their check register. Having to write the amount of the transaction two or three times can also induce the pain of paying because it makes us so much more aware of exactly how much we were spending.  I’ve often said that if every taxpayer had to physically write a check to the IRS every pay period to pay their income taxes instead of through payroll withholding, there would be an uprising in this country that would make the American Revolution look like a mild argument.  

Hagen goes on to say that, with many modern forms of payment, the pain of paying often doesn't exist. We send payments to one another with our phones. We log into an account to link a payment method so we don't have to think about paying when we make transactions. If we go into a store, we tap our card to a reader, and often don't even bother to get a (physical paper) receipt. Because there aren’t as many reminders of how we spend our money with these modern payment methods, we tend to experience the pain of paying much less.

Furthermore, because humans dislike painful experiences, we tend to do more of the things that don't have pain associated with them. And because less ‘pain of paying’ can be associated with some of the more modern forms of payment, many of us have readily opted to favor those payment methods… which means that the pain of more spending-conscious modes of payment, such as paying in cash or with physical checks, isn’t there to help us stay aware of our spending!

And if there is this “numbness” so to speak and no awareness of our costs, most likely will not align with our values. This numbness cold be leading to a path to spending without purpose.  

Now the reason that spending without intention is so concerning is that, ultimately, something has to be the motivation to guide our financial decisions in the moment. Which means if we’re not aware of our spending, we may tend to look to others in our social circles for a clue as to what may be appropriate.  And as we often tend to have the “follow the herd” mentality, our most common point of comparison may be to look to see what everyone else is doing.

As noted earlier, humans have a disdain for painful experiences and will often act to avoid them. So, when someone feels financial stress, they may be tempted to mimic someone else’s behavior if that person appears to be stress-free. The qualification, though, is that because money tends to be a taboo topic for many people, financial stress is difficult (if not impossible) to measure by appearances alone.

In other words, sometimes the person who appears to be living a carefree life with a beautiful house, a beautiful car, and a smile on their face is, in reality, up to their eyeballs in debt and simply better at hiding their financial stress.  We’ve all seen those 20-somethings driving around in a brand-new BMW and wondering, “wow, how the heck can they afford that car??”  Well, sure, they may have a high-paying job and the cash flow to afford it.  But most likely they’re in debt up to their eye balls, but are trying to convey an image.  

At the same time, the problem with spending behavior driven by social comparison is that it can result in feelings of deficiency or even depression when one can’t afford the same things that other people have, even though the reasons for wanting those things may not be apparent or align with your current values.  And the person who does have those things might actually be experiencing overwhelming levels of financial stress themselves, feeling trapped in this “hamster-wheel” of keeping up appearances. Furthermore, the person influenced by social comparison, who feels deprived, may already have all they actually really need!

In essence, a person who pursues goals and makes financial decisions that are based on other peoples' values, instead of acting on their own values, can result in living a life that the person may think they're supposed to live (as determined by others), rather than one that would actually be more likely to make them happy. The number one regret for most people who are close to death is that they’ve lived a life that someone else wanted them to live, instead of the life they wanted to live. 

Let’s switch gears here a little bit and transition into an area that might help you to gain a little better understanding about yourself and the reasoning behind why you make certain decisions.  Although we’re all trying to make objective sense of reality (well, at least some of us,) our brains are not hard-coded in that way, right?  Let’s face it, we’re all making mental mistakes that can impact our ability to make rational judgements.  

In case you were wondering, two of the leading social scientists known for their contributions to this field are Daniel Kahneman and Amos Tversky.  Not only did they pioneer work around cognitive biases starting in the late 1960s, but their partnership also resulted in a Nobel Prize in Economics in 2002. In total, there are over 180 cognitive biases that interfere with how we process data, think critically, and perceive reality. There is no simple way to get around these basic human instincts, but one thing that we can do is understand the specific mistakes we make and why.   

We don’t have time today to discuss all 180 cognitive biases, but I do want to discuss some of the more interesting ones.  Now you can view these biases through the lens of financial decision making, but also for everyday life.

The first one is The Curse of Knowledge.  Ever try to explain something you know intricately and have worked on for many years? It’s hard, because you’ve internalized everything you’ve learned, and now you forget how to explain it. This bias is similar—you know something inside and out, and what is obvious to you is not to others.  We incorrectly assume that everyone knows as much as we do on a given topic.  When we know something, it can be hard to imagine what it would be like not knowing that piece of information. In turn, this makes it difficult to share our knowledge, because we struggle to understand the other party’s state of mind.  Also, another interesting part of the Curse of Knowledge is that from my perspective, it can get scary in realizing that the more you know, the more you really don’t know, if that makes any sense?  My father-in-law exhibited The Curse of Knowledge.  He was a very intelligent man and had the IQ scores to prove it.  However, at times, he grew impatient with others because they didn’t grasp difficult concepts as quickly as he did.  In the world of education, I think many teachers possess the Curse of Knowledge.  How many of you remember sitting in a classroom listening to your high school teacher or college professor and thinking, “this person is obviously very knowledgeable, but I have no idea what they’re talking about!”  I believe good teachers become great teachers when they possess the ability to EXPLAIN the complex to the rest of us.   Also, one major implication of the Curse of Knowledge is that the right people aren’t being listened to.  What I mean by that is the people who are being listened to usually aren’t those in the best position to give advice. We tend to listen to those people whom we perceive have authority. We use social proof as a means to establish the credibility of these authorities. And often that works well, but not always.

How about Belief Bias?  If a conclusion supports your existing beliefs, you’ll rationalize anything that supports it. In other words, instead of willingly looking at new information, we are primed to defend our own ideas without actually questioning them.  We can see this clearly now in the world of politics, can’t we.  People have become so predisposed to think and believe in a certain way, that they completely shut out the opinions of others.  How dangerous is this?  I’m currently reading 1984 by George Orwell and the whole foundation of his story revolves around belief bias.  Groupthink is also prevalent in Orwell’s novel and I’ll have more to say about that in a little while.  In finance, there is a tendency for investors to seek information that supports their decision or thesis and avoid or ignore information that contradicts it.  For example, an investor gets an investment tip from a friend and decides to do some research. While doing research, the investor finds all sorts of positives while glossing over the red flags in trying to “confirm” the return potential of the investment.  As a result, this bias results in a poor, one-sided decision-making process. This bias also occurs to many investors with investments they’ve made recently as people don’t like acknowledging devaluing evidence that might discount their claims.  

So, how does one counter belief bias?  Put your logic "cap" on when presented with an argument, and take emotion out of it as much as possible.  Think beyond your gut reaction that what someone says "makes sense" — consider, using logic, whether what he or she said leading up to that conclusion is true or possible.  If you are given a high-pressure sales tactic, walk away.  Think about if what you are being told about the item really meets the conditions of what you want.  This is why it is always helpful to write down the top five or ten features you want in an appliance/house/car before you buy it.  Turn off your emotions and zoom in on logic.  Do the premises leading to the conclusion also match your belief system?

Next, we have The Spotlight Effect.  Because we each live inside our own heads, our natural focus is on what we’re thinking and doing. We project this onto others, and we overestimate how much they notice about how we look or how we act.  I have experienced this effect first hand.  At the age 39, I was diagnosed with a brain tumor.  The tumor was slow-growing, probably there for years without my knowledge.  Luckily for me it was benign, but had to be removed just the same.  Well let me tell you, I came out of that 9-hour surgery in pretty tough shape.  I had a severe headache for weeks, lost the hearing in my right ear, could not completely close my right eye, had permanent tinnitus in my right ear and facial paralysis on the right side of my face.  For months and even years, I struggled with my appearance due to my paralysis (which still exists but has gotten much better over the years.)  It took me a very long time to realize that I was overestimating how much other people were noticing me.  Sure, occasionally I would get the odd stare from someone, but for the most part, nobody really cared what I looked like.  I was so caught-up with me and clearly was exhibiting the Spotlight Effect.  Some other examples of the Spotlight Effect would be:

• When people wear clothing that they think is embarrassing, they tend to overestimate how noticeable their clothing is to others.
• Similarly, when people wear clothes that are counterfeits of expensive brands, they tend to overestimate the degree to which other people are likely to notice or care that they are doing so.
• When people participate in group discussions, they tend to overestimate how memorable their negative contributions are to other members of the group.
• When people participate in a sport or play a video game, they overestimate the likelihood that their teammates will notice mistakes that they make.

For me personally, it was only after I started to become truly comfortable with myself that I noticed the Spotlight Effect disappear from my life.  

Have you ever heard of The Framing Effect? Context and delivery can have a big impact on how a story is interpreted. We all like to think that we think independently, but the truth is that all of us are, in fact, influenced by delivery, framing and subtle cues.  This is why the ad industry is A Thing, despite almost everyone believing they’re not affected by advertising messages.  Here’s a simple example:  Imagine you are in the grocery store and you want to purchase healthy yogurt (and let’s pretend that your definition of healthy is the elimination of fat). You see two tubs of yogurt. One says it’s ‘99% fat free’, the other says it’s ‘1% fat’. If you think about it, both yogurts make the same claim about their fat content. However, people are more likely to choose the ‘99% fat free’ yogurt. The only difference being that the fat content was framed differently.  Another example of Framing would be that you are required to decide between two elective courses for your final semester in college. You are determined to maintain your high GPA, and you talk with the professor of each class. One tells you that 20% of the students procure A’s while the other tells you that 80% of the students fail to get an A. You choose the former over the latter.  One technique to avoid unwanted Framing would be to try to actively change the frame - also known as “thinking outside the box”. If you are facing a problem, you might have a better shot at solving it if you frame it differently. For instance - instead of focusing on how to speed up a slow elevator, try to ask about ways to make the ride more enjoyable. Reframing is about finding alternative representations of the same situation to get a fresh perspective.

We must have the humility to recognize that we can be manipulated, and work to limit the effect that framing has on our critical thinking.

A bias that we’ve all experienced at one time or another is Availability Heuristic or in another words, your judgements are influenced by what most easily springs to mind.  One example of availability heuristic is airplane accidents. Often, people hear about horrendous crashes or explosions that kill many people. For example, US air carrier, Southwest Airlines, experienced a mid-air engine explosion in 2019 that killed a passenger. In the aftermath, the company saw a sharp decline in ticket sales, with the firm losing between $50 million and $100 million in sales. Consumers inflated the expectation of a similar incident far beyond its actual likelihood.  Politics is a prime example of availability heuristics in action. For instance, politicians usually stick to a couple of key areas and nail home their point. Usually, these points will appeal to the masses. Whether it’s immigration, healthcare, or schools.

We’ve seen it time and time again. Politicians promise the public they can fix a problem. They get elected and fail to fix it. However, the next candidate comes along and promises they can. They get elected and equally fail to fix the problem – thereby creating a vicious cycle.

What happens is voters will tend to forget about the unfulfilled promises made by the incumbent. Instead, they hear about the promises from the new candidate, which takes prominence.

Again, a successful way to manage this bias is finding alternative representations of the same situation to get a fresh perspective and think outside of the box.  

Anchoring can be especially important during financial negotiations.  It is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. During decision making, anchoring occurs when individuals use an initial piece of information to make subsequent judgments.  When dealing for houses, cars and salaries because the initial price offered has proven to have a significant effect.  Think about how many times you were in some type of financial negotiation, say like buying a new car.  You would do your research, come up with a reasonable price for the car, and then offer a few thousand dollars LESS than that.  That low-ball price is your anchor.  Skilled negotiators do this all the time, setting the anchor price either too high or too low depending upon which side of the buying or selling table they are on.  My point here is that no matter what side of the table YOU are on, don’t be too heavily influenced by that initial piece of information.  So the next time you are trying to make an important decision, give a little thought to the possible impact of the anchoring bias on your choices. Are you giving enough consideration to all of the available information and all of the possible options, or are you basing your selection on an existing anchor point?

I mentioned George Orwell’s 1984 earlier in the show.  A prominent theme that runs throughout that novel is called Groupthink.  It is a cognitive bias which encourages people to desire harmony or conformity within a group. In many cases, people will set aside their own personal beliefs to adopt the opinion of the rest of the group.  Research has shown that Groupthink becomes stronger when the group members are very similar, increasing further when there is a powerful and charismatic leader in the group too.  Groupthink can also happen when there is stress or some type of moral dilemma, especially if the decision has to be rushed it can lead to poorer decision making and outcomes.  There are two examples of this bias, one of which is the Bay of Pigs invasion in which President Kennedy made a decision to try and attempt to topple the communist government of Fidel Castro of Cuba, which failed. The people around the President supported his decision to go ahead and kept their own concerns at bay. If Groupthink didn’t happen then it could have led to a different decision.  The second example is the Challenger Space Shuttle disaster where the engineers of the space shuttle knew about faulty parts with the shuttle plenty of time before takeoff. Instead of reporting it they decided (as a group) to push ahead with the launch anyway to avoid negative press.  Can you think of any other examples?  I can think of a very dangerous one in which the jury in a murder trial might unconsciously fall into Groupthink, especially if there was one or several persuasive members of the group.  For a great example of Groupthink on the Hollywood big screen, check out the 1957 classic, 12 Angry Men.  

The last cognitive bias I would like to discuss is The Dunning-Kruger Effect, named after social psychologists David Dunning and Justin Kruger.  The Dunning-Kruger effect is a cognitive bias in which people wrongly overestimate their knowledge or ability in a specific area. This tends to occur because a lack of self-awareness prevents them from accurately assessing their own skills.  So, What causes the Dunning-Kruger effect? 

Confidence is so highly prized that many people would rather pretend to be smart or skilled than risk looking inadequate and losing face. Even smart people can be affected by the Dunning-Kruger effect because having intelligence isn’t the same thing as learning and developing a specific skill. Many individuals mistakenly believe that their experience and skills in one particular area are transferable to another.  A common example in finance would be when a beginner stock market investor feels much more confidence around their abilities than their actual skill levels.  Again, this is a common bias in the financial advisor’s world and one that I’ve experienced myself.  

Initially when I first started learning about the numerous topics in financial planning, I felt really good.  My confidence level shot up.  But then as I kept learning more and getting more experienced, my confidence level actually started to come down. The more I learned, the more I realized what I didn't actually know initially, and the lower my confidence got.  I thought to myself, “Who am I to be giving life-altering advice to people I hardly know?”  But it was only after this long valley of reduced confidence, that I gained more experience and increased my knowledge to the point where now I feel fully confident in what I do and have full conviction in what I say to my clients.   

Well, I think it’s about time to wrap-up our journey through the world of emotional money management and thank you for letting me be your “Armchair psychologist” for a while.  Hopefully you’ve learned a little more about the importance of emotions in the decision-making process and perhaps you’ve even learned a little more about yourself.  I know that I have.  Now I would say that it’s nearly impossible to take all emotions out of the decision-making process.  But take a second look at the 8 cognitive biases we have explored today.  Do you see yourself in any of them?  What can you learn from them and how might you change your decision making based on what you learn?  It’s a journey for sure, but one that is full of self-examination and personal development.  Good luck and enjoy your journey!  

Thanks again for listening.  Stay tuned for our next podcast of Invest in Knowledge in early February.  

I am a registered representative with and securities are offered through LPL Financial, Member FINRA/SIPC. Investment advice is offered through Private Advisor Group, a registered investment advisor. Private Advisor Group and Albany Financial Group are separate entities from LPL Financial. 

 This episode makes reference to an article “Using a Financial Purpose Statement to Guide Mindful Spending Decisions,”  written by Derek Hagen and published on www.kitces.com  on December 15, 2021.  

The opinions voiced in this Podcast are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.