Evan Harp sat down with Dr. Preston Cherry to discuss financial psychology, how it differs from behavioral finance, and how advisors can benefit from incorporating it into their practices.
Evan Harp: My first question is, what does financial psychology mean?
Dr. Preston Cherry: In general, financial psychology is about the way people think, feel, behave, and act with their money. It is the emotions of money; it’s the human side of money, which also reveals people’s stories, their values, their experiences, their cultures. And how those things reveal someone’s relationship with money. That information that is unpacked or uncovered through discussion, the discovery of financial psychology, that’s what informs the money.
Harp: Excellent answer. Another question I have related to that is perhaps a bit in the weeds and technical, but is there a difference between behavioral finance and financial psychology?
Cherry: Yes. So behavioral finance — 1.0, so to speak — the original definition deals with cognitive decision-making with your investments or your money decisions.
I would say that investments and money decisions, particularly with investments, are about choices, right? The keywords are “cognitive or biased.”
Let’s go to behavioral 2.0, which is a euphemism for financial psychology. Behavioral finance 1.0 was limited because it kept you in a cognitive decision box. For instance, if you’re making a decision, like mental accounting, that’s very cognitive. Are you going to put money in this box or in this other box? That’s cognitive, but it doesn’t explain why you put that money into those two boxes from a broader emotional and psychological spectrum.
To compare the two: Behavioral finance generally deals with investments and then money decisions overall — so, savings, etc. With financial psychology, you can apply it to the whole financial planning and personal finance spectrum. And then it gets into those human elements, right? Think, feel, behave. Past, present, future. The emotions. The deeper realm of why.
The Personal Side of Financial Psychology and Money Decisions
Harp: It sounds like it’s very catered to an individual’s history and experiences and how they think about planning out their money decisions.
Cherry: Well, both deal with the individual. When you’re talking about cognitive decision-making, if you feel a loss more than a gain, that’s loss aversion. Right?
Loss aversion, mental accounting. You’ve heard these terms before. So then, what’s the next question after that, Evan? “How do you feel that way?” and “Why do you feel that way?” And I say, “How do you feel that way?” because it is more of an open question. When you are talking about motivational interviewing, you don’t want to be judgmental, and say, “Why do you feel that way?” Instead, it’s helpful to frame it more like, “Tell me more about that choice.” What influenced that choice regarding your relationships with money over time? Can you tell me a little bit more about that?
When talking about saving and investing your money over time, did you see anything in your past that may have influenced your decision, informed your decision-making, or even your relationship with money as an adult directly? Any experiences, even some cultural influences? You may have seen something like that. Any of those things could influence your thought process or your perception here.
Sometimes then they’ll go into some sort of story. “My grandmother did this,” or “My aunt or my mother told me about this,” or “My dad told me that, right?” Then the stories open up and inform the direction, aspirations, and outcomes.
I’m kind of pivoting here to what I call the Arc of Financial Wellness™, which is four steps. This goes back to your point about the difference between behavioral finance, cognitive decision-making, and financial psychology — which is the discovery of the human emotion and the humanity not behind but with the money. It’s the relationship with money: think, feel, behave.
The Arc of Financial Wellness™
Let’s get back to the Arc of Financial Wellness™; this should hopefully bring it home, which is people’s pushback with financial literacy. The problem with the phrase financial literacy is that, first of all, it has a negative connotation. Because it may allow one’s mind to say that somebody is financially illiterate! There’s a negative side to it, potentially — a negative, judgmental word that could lead people to draw a negative conclusion. That’s number one.
And number two, folks brush aside that financial literacy is about informed decision-making and behavioral decisions. Many folks push back and say, “Okay, why are we starting measurement of literacy at this juncture? If folks don’t have compassion or information before that decision, is it fair to ask people financial literacy questions at that juncture?”
What’s the keyword? The keyword is informed. All right, well, what do you get the information from? So, you need two more steps, which is where financial psychology comes into play. In the Arc of Financial Wellness™, financial compassion, and financial education come before financial literacy.
Harp: I like that term.
Cherry: Financial compassion? Yes, financial compassion. And this is where empathy is embedded in compassion because empathy is understanding, and being aware of another’s viewpoint or situation. Empathy means you can really experience yourself in someone else’s shoes. Empathy means you have a direct relationship with that feeling because you’ve had it before or you yourself feel it too. It allows you to have an understanding of somebody, compassion goes a little bit further. You don’t necessarily have to have a direct experience with what that person is feeling to have compassion. But it does allow you to have the top-level understanding, awareness, and mindfulness, which allows you to understand someone’s viewpoint without directly feeling it or the need to feel it.
Number two, providing a suggestion or framework for action to address the matter. Number three is possessing the willingness to learn, understand, and help. Compassion contains those three elements; it has empathy inside of it. That is compassion.
Financial compassion has no judgment, no shame, and it asks questions to uncover and unlock culture, values, experiences, and relationships with money. Think, feel, behave. Past, present, future. All that is financial compassion and part of financial psychology.
When you open up the heart, you open up the mind because somebody feels belonged, valued, and heard.
Financial education is the second step. It doesn’t matter whether you’re in financial coaching or financial advisor spectrum — talking to the community or teaching the second step fits everyone. In every model, someone is going to be more receptive to a financial planning recommendation and education if you’ve heard them. First, is financial compassion. Then, financial education. Then you have financial literacy, which is when they’re informed now! They got their informed decision-making and behavior. Are they more or less inclined to make better decisions and better behaviors at this point?
Harp: I would say more at that point.
Cherry: At that point, yeah. Because they have the information, and also they feel connected as a human being.
Now you have the fourth step, which is achieving financial wellness. Because you’re making better decisions and have better behaviors with money and your life, financial wellness is achievable. Financial wellness is about having overall well-being tying your life and money together to achieve a sense of security and control and confidence. Financial well-being.
Navigating Systemic Challenges With Financial Psychology
Harp: My next question was going to be, “How can financial psychology help advisors?” but you made that pretty clear there in terms of how it connects all these different dots and pulls it all together. So, I’ll try a different question for the next one. All of what you’ve covered makes a lot of sense — how an individual gets through their own journey on their own arc of financial wellness, personal connection, and empathy leading to receptiveness to education.
We touched a bit on how cultural influences could indicate how somebody feels about or interacts with money. So, when I think broadly about the financial systems that we live in and their limitations and shortcomings, are there broader societal changes that can help with financial psychology for people, or are there specific systemic solutions that we should also look at?
Cherry: That’s a new question, Evan! So yes. Societies have these systems. Some people benefit more than others. But we can, for the most part, at least in America, plug into it. There’s access. What am I getting at? Societies are systems. There’s a form of conditioning, we’re all conditioned, good or bad. But this is why education and history are so important — because this is the human condition. If the systems would do a better job in having a human condition mission with their conditioning, then we’d all be better for it.
We’d be better if we had better social studies, if we had better money studies. These family relations stories — I would just listen to my grandmother recall 200 years of history that affected our family. That’s incredible. My point about this is, what can we do as a society for a system to help advance the human condition? What can we do to advance the human condition, particularly with money? Encourage more money talks in the home with children early to reduce shame and judgment around money events over a lifecycle? Everyone has money events.
Financial psychology applies to everyone across the socio-economic spectrum, even the affluent and wealthy. Sometimes they don’t think they need it, or this is just for some type of folks. And that’s untrue. It’s just where you start on your journey. I had an older gentleman tell me one time — he was 80-some years old, he has all this money, a lot of money. Like true wealth, blue blood money. It’s not the dollar figures anymore what he was most afraid of. He was most afraid of having a family conversation on how to pass on the legacy. Getting everybody in one room. That’s financial psychology — encouraging cross-generational talks, encouraging more financial education in our school systems and universities.
Financial Therapy and How Advisors Can Use It
Harp: That makes a ton of sense. I have plenty of people in my life who have grandparents who are alive, who grew up adjacent to or even during the Great Depression, right? That affects how that generation thinks about money compared to people who grew up in better financial climates.
Cherry: One last note — I would encourage more financial therapy, which is under the financial psychology umbrella. We have financial psychology, behavioral finance 1.0, behavioral finance 2.0, financial therapy, and coaching. Coaching is coaching behaviors and decisions for a specific thing, like paying down debt. Coaching is a form of psychology as well, because it uses encouragement, small wins, smart goals — encouraging folks to process their relationship with money, past, present, and future.
I would also say it’s important to keep financial education throughout adulthood. Talking with your spouse, getting information from trusted resources — even on the internet. All of that continues to grow your personal finance knowledge to align with where your life and money journey are going across your lifecycle.
Harp: I have one more question on all of this that will be useful for our readers. For the advisors who might not have thought a lot about financial psychology, having just read this interview right now and seeing that it could be a useful thing to start incorporating into their practice — If you’re one of those types of advisors, what do you do? Where do you start looking to key into some of these ideas?
Cherry: There’s a couple of resources. There’s an article called “Integrating behavioral finance, financial psychology, and financial therapy theory and techniques into the financial planning process.” Megan McCoy has done has a little bit of this as well.
I’ve done many presentations on this on the speaking circuit. I have money psychology meetings, specifically to investigate relationships with money, asking how communications are going on in the home. What’s your perception of your money? How do you emotionally integrate this? How do you integrate it into your internal and external connections and communications?
There are also several podcasts. Sydney Devine, Ross Marino, Saundra Davis, Dr. Michael Thomas, and Meg Lurtz are all worth checking out. And Brian Portnoy! Shaping Wealth is good, and Brian’s my dude, he’s my guy. I just had breakfast with him a couple of weeks ago.
One more thing — financial psychology is the glue between life and money. It’s hard to have one without the other. This is where I got the term Life Money Balance® from: “Let your life lead your money, not your money lead your life, so your life and money work concurrently to achieve your life design.”
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