Financial Psychology: The Art of Knowing How to Invest

August 16, 2019
If you want to make smarter financial decisions, take advantage of the resources that financial psychology has to offer. This field of study offers strategies that will help you make the best money-related decisions possible.

Taking the time to learn how to manage your money is a great idea, no matter your current financial situation. After all, according to psychologists, humans naturally make a lot of mistakes when it comes to money. Thus, financial psychology could just prove to be your new best friend.

In this article, we’ll talk about the relationship between psychology and finances, what financial psychology actually is, and the benefits of taking charge of your money. Don’t become your own worst financial enemy! Instead, read these tips and try to apply them in your life.

“Never spend your money before you have earned it.”

-Thomas Jefferson-

Financial psychology in a nutshell

Psychology focuses on the cognitive, behavioral, and emotional aspects of being a human being. Economics, on the other hand, is “a social science concerned chiefly with description and analysis of the production, consumption, and transfer of wealth” (Merriam-Webster).

But what’s the relationship between the two? They both study human beings and believe that people behave in such a way that improves their well-being. Also, they both consider human needs and how to relate to those in order to live better.

Two human profiles superimposed on one another.

Psychology vs. economics

Thus, both sciences try to analyze behavior and how that affects decision-making. The difference is that they do that from different perspectives. For example, economics seeks to describe collective behavior, while psychology focuses on the individual. What’s more, the research tools are quite diverse. Economics relies more heavily on the deductive hypothetical method. Margarita Billon Curras from the Autonomous University of Madrid wrote about this in her article “Psychology and Economics from a Multidisciplinary Perspective”.

Psychology, on the other hand, leans more towards health sciences and looks beyond cultural influence, spending, and people’s relationships with material things.

The two fields do have common ground, however. Here’s a non-exhaustive list of some of their shared interests:

  • Consumer behavior.
  • Publicity and marketing.
  • Individual differences.
  • Economic socialization.
  • Politics.
  • Corporate behavior.
  • Financial markets.
  • Decision-making.
  • Identity.
  • The meaning of money.

What’s financial psychology?

Financial psychology is the discipline that studies money-related behaviors. More specifically, it analyzes the interaction between financial markets and human nature.

By analyzing people’s behavior, it reveals the psychological barriers that affect their financial decisions. Consequently, it provides insight into people’s actions, which can help everyone be more financially aware.

It also identifies the unconscious aspects of money-related decision making. Having that awareness can help you be more assertive. Financial psychology doesn’t just study the individual, however. It also takes into account environmental influence and how you were brought up.

Stop being your own worst enemy

James Montier is one of the most well-known investors today. His book The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemytalks about how people relate to money and how to change your behavior to overcome obstacles.

Here are some of the steps you can take to stop being your own worst financial enemy:

  • Manage your emotions. If you do that, you can avoid the chaos that might lead to losing money.
  • Don’t be overly trusting. If you aren’t cautious enough when you invest, you’ll end up with smaller returns than you expected.
  • Focus on the positive. Don’t let losses get you down. It’s better to let them go and focus on something promising. Try to not make decisions that you know will be disastrous for your investments.
  • Avoid doing the same thing over and over again and expecting different results. The better option is to take a good, hard look at the situation, make an assessment, and then take action.
  • Face reality. Everyone makes bad financial decisions at some point. Let them go, but be assertive. For example, if you have to make a decision, don’t let your emotions get in the way.

Your personality plays a role

On the other hand, keep in mind that you aren’t perfect, nor should you be. It’s important to know yourself, be genuine, and use strategies that will improve your well-being.

It’s also important to know that there are unconscious mechanisms at work in your relationship with money. Your personality traits also play a role, which is why some people have such a hard time making good financial decisions. Don’t be afraid to ask for help. You can consult a financial advisor or an expert in financial psychology for tips on how to be more assertive.

A jar with a plant growing out of coins.

Benefits of financial psychology

There are advantages to applying the principles of financial psychology or seeking advice from a financial psychology professional. Doing so will ensure that you:

  • Get a higher return on your investments.
  • Understand why you’re making decisions that are bad for your finances.
  • Overcome financial obstacles.
  • Increase your awareness of your finances.
  • Understand the behavioral problems that lead you to make bad decisions.
  • Explore your financial behavior.
  • Understand your relationship with money.
  • Identify the psychological barriers that affect your money-related decisions.
  • Learn from your financial mistakes.
  • Be more resilient.
  • Release tension.
  • Identify the most common investment mistakes.

In conclusion, inviting financial psychology into your life will teach you about the wonderful art of knowing how to invest. Although it isn’t simple, it’s a lesson you can learn one step at a time. Every decision you make tells you something about yourself.

Financial psychology helps you be more assertive with money. Thus, it’s a wonderful way to understand your relationship with money and know which path will benefit you the most.

“It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.”

-Robert Kiyosaki-

  • Billón Currás, M. (2002). Psicología y economía desde una perspectiva interdisciplinar. Encuentros multidisciplinares, pp. 1-8.
  • Montier, J. (2011). Psicología financiera: Como no ser tu peor enemigo. Deusto, Barcelona.