Psychology of Financial Planning

CHAPTER 1Financial Instincts: Why We Are Bad With Money

In the late twentieth century, economists began to come to terms with what psychologists had known for hundreds of years: Human beings do not always act rationally and in their own best interests. In 2000, then‐future Nobel laureate Richard Thaler predicted that the field of economics would evolve to incorporate this basic acceptance of human psychology. Rather than assuming that human beings are rational financial actors, he believed that economics would shift to developing more realistic assumptions about actual financial behaviors. Specifically, he anticipated that economics would focus more on the exploration of human cognition and emotion and how they impact financial decision‐making [1]. If we want to understand, predict, and help shape financial behaviors, we need to understand how humans think and feel, and the impact of cognition and emotion on financial behaviors. In this chapter we focus on the impact of financial instincts on our financial psychology, as illustrated in Figure 1.1.

THE SURVIVAL INSTINCTS OF OUR ANCESTORS

When it comes to money, food, exercise, or anything that takes us outside our comfort zones, our brains are wired to do it all wrong. As we said, they are in desperate need of a software update, because we are designed for hunting and gathering and not the complexities of modern life. When the power of our primal instincts are considered, it's a miracle any client follows the advice of a financial ...