Psychology of Financial Planning

CHAPTER 2Behavioral Finance: Understanding Cognitive Biases and Heuristics and What to Do About Them

Financial psychology is the application of many fields of psychology to personal finance. These fields of study include, but are not limited to, behavioral psychology, cognitive psychology, developmental psychology, neuropsychology, personality psychology, social psychology, cognitive psychology, clinical psychology, abnormal psychology, marriage and family psychology, and multicultural psychology. Financial psychology seeks to integrate science, theory, and practice to understand and predict financial behaviors, as well as to promote sound financial decision‐making and good financial health.

Behavioral finance seeks to understand people's instincts regarding money and, at the risk of oversimplification, figure out why they tend to make poor financial decisions [11]. Much of the early work integrating psychology and finance grew out of the field of behavioral finance, which applies just one branch of psychology to personal finance – the cognitive. Instead of diving into specific experiences, family patterns, and relationships, and how specific beliefs can impact a person's relationship with money (which we will explore in great detail, along with the planner's role in addressing it, in the rest of this book), behavioral finance hones in on common human cognitive and emotional biases and the ways we make sense of the world around us. It examines how normal human cognitive processes ...