The psychology of money

13 July 2018

Jason Andriessen CFP®

Jason Andriessen CFP® is the managing director of CoreData.

Financial stress is a major issue for many Australians. Financial planning professionals are well placed to help them deal with the causes, with the benefits of advice extending well beyond just money.

Australians worry about money more than anything else in life. The Australian Psychology Society says its research shows financial issues are the leading cause of stress amongst Australians; higher, even, than worries about health.

Feeling worried about money is uncomfortable, but it’s actually much worse than that. Financial stress negatively impacts our families and our communities. Those who feel financially stressed drink more, sleep less, have worse mental and physical health, and have more conflict in their personal relationships.

The good news? CoreData research has identified the main causes of financial stress. And financial planners are well-placed to do something about it.

Financial stress is caused by struggling to meet short-term financial obligations. Those who feel most financially stressed have the most trouble meeting their immediate expenses – things like bills for utilities, as well as rent or mortgage payments.

Financial planners know that people’s difficulty in meeting short–term financial obligations often stems from a lack of discipline and impulse buying behaviour. Financial planners are in the box-seat to work with clients to help them budget, manage their debts, and build financial knowledge.

It’s easier said than done, but growth-minded professional advisers can seize the opportunity to address money psychology and encourage clients to change the decisions they make and the actions they take.

Clients will feel more in control and feel less financial stress, which will benefit their families and the broader community.

And financial planners will benefit too, because when clients feel less financial stress, they’re more capable of making decisions to manage risk and plan for the future. And they’re more likely to engage the services of a professional.

According to the Australian Psychology Society’s Stress and wellbeing in Australia survey 2015, financial issues are the leading causes of stress, with an average prevalence of 49 per cent over the previous five years of respondents affected. Financial issues cause more stress than family issues (45 per cent), health issues (44 per cent), and workplace issues (32 per cent).

It has been said that behind physical wellbeing, financial wellbeing is the most important contributor to quality of life. If that is true, then financial stress is the elephant in the room that needs to be addressed as a matter of urgency.

Being financially stressed is no fun

Drugs and alcohol: CoreData research conducted for Financial Mindfulness in 2017 found that those who are suffering from financial stress are more likely to turn to drugs or alcohol as a way of coping. Over one in three (35.2 per cent) Australians suffering from financial stress have used drugs or alcohol to manage negative feelings associated with financial stress. For those who are not financially stressed, the proportion is just one in 50.

Sleep: The same study found that financially stressed people sleep worse – more than seven in 10 financially stressed people often lose sleep worrying about money. Less than one in 10 of non-financially stressed respondents claimed to have lost sleep worrying about money.

Physical health: Around three in five financially stressed respondents believe that their physical health has been negatively impacted by money worries, and the same proportion have experienced anxiety and depression.

Family relationships: And the vast majority (three in four) of financially stressed people believe that money is a factor in conflicts with close family members. For those who aren’t financial stressed, money is rarely a cause of conflict (just one in five believe it’s often a factor in arguments).

It’s an ugly picture, but understanding the root causes of financial stress, and the potential remedies, is integral to the financial planner’s role and a very significant part of the value the planner brings to the client relationship.

And the benefits may go well beyond just the financial – a planner who successfully reduces a client’s financial stress may also potentially lessen the client’s tendency to turn to alcohol or drugs, help them sleep better, and improve the quality of the client’s family relationships.

People spend what they earn

People feel financial stress when they have difficulty meeting a short-term obligation, like a mobile phone bill or a mortgage payment.

There are many contributing reasons for people being unable to meet their short-term financial commitments, but financial planners know it really comes down to one thing: people tend to spend what they earn. Worse, they sometimes spend more than they earn, maintaining a lifestyle or simply making ends meet by using expensive and inefficient debt.

Financial stress isn’t necessarily about how much someone earns, but how much they spend. Even high-income earners can suffer from financial stress, and for exactly the same reasons as people on much lower incomes. Financial stress arises when they spend their money on discretionary items, either through a lack of planning or by acting impulsively.

Everyone knows, deep down, they need to spend less than they earn, including Charles Dickens. More than 150 years ago he said: “Annual income – twenty pounds. Annual expenditure – nineteen six. Result, happiness. Annual income – twenty pounds. Annual expenditure – twenty pounds ought and six. Result, misery.”

But just telling people they should spend less isn’t particularly helpful. If it were, it would be an easy issue to address. People know they should spend less, yet they just don’t do it.

Money psychology – or behavioural economics, to use its formal description – recognises that traditional economic models assume people are perfectly rational when it comes to making decisions about money. But people are far from rational, and so the traditional models just don’t adequately explain how and why people make decisions and behave the way they do.

Nudging people into action

Financial planners can harness the key concepts of behavioural economics to reach the financially stressed and help them make, and action, better decisions.

This is commonly achieved through a process called ‘nudging’. It demands only small, non-threatening changes in people’s behaviour at any point in time. But the cumulative effect of repeated nudging produces a significant end result.

For example, super funds often write to their members and advise them that in order to have a comfortable retirement they will require $60,000 a year to live on, and to fund that, they will require a balance at retirement of more than $1 million in today’s money. They provide a projection, advise on the gap, and then expect their members to take action. But usually their members don’t.

They don’t because of cognitive dissonance – the discomfort someone feels when their behaviour is disconnected from their values system. Everyone wants a comfortable retirement, but not many everyday Australians have a projected super balance of $1 million. In fact, they don’t have anywhere near that amount. It all feels too hard and uncomfortable, so they disengage from the decisions.

Super funds would have more success if they harnessed social influence and communicated to their members what other people like them are doing. And by helping members understand that only small changes to their behaviour can enhance their money outcomes, no matter where they are today and no matter what mistakes they’ve made in the past.

Start with budgeting, then go to planning

Mental accounting helps with budgeting. If clients are able to compartmentalise their money according to its purpose, then it’s easier to stay disciplined and there will be money available to pay the bills and rent. So, financial stress reduces.

And when financial stress reduces, then clients have the headspace to start thinking more clearly. They’ll move on to debt management, and then start setting long-term goals. They’ll be more willing to think about managing their risks, and then they’ll be willing to work on a plan for their future.

There’s a logical and simple path through the process along which advisers can help people walk. And as with any great journey, it begins with a single step. It gathers pace as they become more confident with making financial decisions, and as they begin to recognise and experience the benefit to their overall wellbeing.

People worry about money. They worry when they don’t have enough to meet their financial commitments, and they worry when they think they will not be able to get ahead.

It’s no fun to be financially stressed, and it’s no fun when they feel like they’re always playing catch-up. It spills over into most other areas of life.

But financial stress often has a relatively simple cause and therefore, a relatively simple remedy. It essentially stems from overspending; and overspending happens when people can’t budget effectively and when they can’t control their impulse to spend. Financial planners are ideally and perhaps uniquely placed to help.

Advisers who understand behavioural economics can help clients solve their short-term financial issues and moderate behaviour. And once they’ve helped someone solve a short-term issue, trust begins to grow.

Trust is the foundation of all great long-term relationships, including those between adviser and clients. Helping people with even very simple concepts and revealing to them the demonstrable benefits they can achieve, sets the foundation for a long and rewarding relationship for adviser and client alike.

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