Building Good Financial Habits

Financial savvy and know-how are vital when getting your finances under control, but an important aspect that’s often overlooked is the psychological component.  I want to spend some time today going into the psychology behind the building of good habits and breaking bad habits and how that can apply to making sure you’re building your financial well-being on a solid foundation.  As I’m sure you can guess, I’m not a psychologist so I won’t be delving too deeply into that field, but instead trying to translate what’s happening psychologically into how that can affect finances. That being said, let’s start with something basic.

Positive Reinforcement

One of the most basic learning processes is the idea of positive and negative reinforcement which has guided us throughout the entirety of our evolution.  Looking at positive reinforcement, the idea is that you see something that looks good like food, you eat the food and discover that it does in fact taste good, and as a reward you feel better.  This is especially true with sugar and sweet foods. Simple, but you have trigger, behavior, and reward at which point your brain tells you to repeat the process. This process starts with a need, we’re hungry and need calories so we see food and eat it in order to gain the calories to continue living.

However, our brain is so smart that it says “this food makes us feel good, I bet the next time you feel sad or angry, eating this food will make it better.”  We agree that feeling better is the goal, so the next time we feel angry or sad we’ll eat something we know makes us feel better such as cake or ice cream. Now we’ve replaced the trigger of needing to eat with an emotional trigger of wanting to feel better, and by repeating this process over and over it becomes a habit.  By that simple act of your brain telling you that by eating ice cream or cake you’ll feel better you’ve turned a process that was designed to prolong your life into something that’s actively killing you. To me, it’s fascinating that such a necessary evolutionary process can be effectively hacked to create a situation completely counter to what it was designed for.  I used the example of sugar, but it can also be easily applied to smoking. You see cool people smoking and you want to be cool, you start smoking to be cool, you feel better. The trope of the cool kids and the rebels smoking is well worn in our society and is useful in providing a signal to those who want to be cool that this is how it’s done. It’s no wonder then that two of the leading causes of preventable death are obesity and smoking.  Now that we have that process established, how does it relate to money?

Building Financial Habits

Understanding how habits get formed through the reinforcement process is vital to understanding how best to build your financial well-being.  It’s great to know all the high level information and have what you believe is the perfect asset allocation, but it can all be toppled if you don’t know the basics on why your brain falls into the same traps over and over again.  The major example I want to look at even has its own name: Retail Therapy. This is the most obvious example of how our brains trick us into making decisions that go against our overall best interest. Just like with sugar, we see something we want, we buy it, we feel good, repeat.  Trigger, behavior, reward. Our brain then says “hey, remember how sugar made you feel good when you were feeling sad or angry? I bet buying something you want can have the same effect!” Before we know it we’re stuck in a loop of buying something for ourselves whenever we feel bad and that can quickly get us into trouble financially.  Credit card companies know that people fall into this trap and make it as easy as possible to use credit cards without needing to think about the potential consequences. So, what are some easy steps that can be taken to help stop this process?

Don’t Give Yourself the Ability

Part of the financial planning process is looking at what goals you want to achieve and finding ways to automate the processes so that you don’t get the chance to spend frivolously.  A great place to start this process is by being mindful and intentional in your financial goals. Studies have shown that simply by being curious about a habit or a behavior can lead to a deeper understanding of that behavior and help to break its influence over your actions.  If you take the time to really be curious about what your goals are and what’s most important, we can create a plan to get you there and make sure that processes are in place to help prevent derailment. This process of being mindful of your goals and putting down what’s important to you works as a two pronged attack on getting rid of bad habits.  By being intentional about your goals, you’re able to remove yourself from the cycle of instant gratification and view things on a longer term scale. This will help show retail therapy and other instant gratification for what it is, very short term contentment at the expense of longer term happiness. The other prong is what I’ve mentioned before, putting automated processes in place to reduce the ability to indulge in destructive behaviors or habits.  

I know that this is all pretty basic psychology, but I think it’s important to understand how these habits get formed and why we fall prey to them.  Just as when the market shifts we go back to why money is important to you, we need to look at why these habits have such a hold on our lives and how they’re affecting our financial well-being.  So, to end on a positive note, what positive behaviors or habits have you cultivated? How have you done so, what is it intentional or did it happen by chance? What positive financial habits have you formed in your life and where did you learn them?  I’d love to hear your experience, so please email me if you’re willing to share.