Behavioural finance concepts and ways to inculcate into financial planning
The professionals in the field of financial planning are increasingly realising that it should be blended with psychological theories and techniques. There are various theories from varied disciplines of psychology that can be directly used for the benefit of financial planning.
The broader integration of psychology into the world of personal finance has been termed as financial psychology. Financial psychology is drawn from behavioural finance and other areas of psychology to encourage healthy financial behaviours. It is not only limited to cognitive biases but also, goes beyond into the realm of a client’s idiosyncratic beliefs and financial behaviours such as resisting financial advice, overspending, etc.
To overcome such a psychological barrier, cognitive behavioural therapy (CBT) is used. This is based on the theory that any inaccurate or unproductive thinking is the source of self-defeating behaviours. In other words, the way that individuals perceive a situation is more closely connected to their reaction rather than the situation itself. When it comes to financing, what leads to such a reaction is an individual’s beliefs about money that is shaped by a variety of individual, developmental, and cultural factors as well as specific money beliefs. For example, a person believes that he or she is too dumb to understand retirement planning is impeding his or her savings behaviour. All these factors lead to disordered financial behaviours.
You can overcome this by applying CBT techniques. The following five steps must be kept in mind while applying this technique:
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Identify your irrational monetary beliefs
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Challenge those irrational beliefs
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Test the validity of those irrational beliefs
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Create a replacement belief
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Modify your behaviour as per rational monetary beliefs
To implement the above process, you need to consider a financial situation that causes distress and record the emotion associated with it. Identify the money-related thought, or money script, underlying with that emotion and then, develop an alternative money script that will promote positive financial behaviours. If you follow this, you will be able to improve some of your problematic money behaviours like hoarding, gambling as well as compulsive buying disorders.