Monday, 21 October 2019

Financial psychology

Financial psychology

There is a growing interest among financial planning professionals in the blending of psychological theories and techniques with financial planning. The most recent edition of the CFP Planning Competency Handbook (CFP Board, 2016), as well as this text, illustrates this integration. While behavioral finance has been described as the application of psychology to finance, we argue that it is more accurately described as the application of cognitive psychology to finance (Klontz & Horwitz, 2017; Klontz, Kahler, & Klontz, 2016). Viewing the totality of financial behaviors exclusively through the lens of cognitive psychology, which is a laboratory versus applied science, has resulted in limited practical applications for financial planners working with clients. In contrast to behavioral finance, financial psychology applies findings from a diverse body of research across many subspecialties of psychology and draws from elements of clinical psychology to help improve a client’s financial well-being.

Key theories from many disciplines of psychology are of direct relevance and benefit to financial planners and their clients. Research findings from fields such as social psychology, personality psychology, multicultural psychology, positive psychology, humanistic psychology, and developmental psychology can be applied to financial planning. Tools and techniques from many of these fields have already been adapted for use with clients. In addition, strategies from various modalities of psychotherapy, including cognitive-behavioral, motivational interviewing, solution-focused, and positive psychology strategies, can be used to improve rapport with clients and increase the success of financial planning.

This chapter explores the link between behavioral finance and cognitive psychology, as well as the practical limitations of behavioral finance to the practice of financial planning. This chapter follows with a discussion of what financial planners need and how the field of financial psychology can assist. The chapter concludes with a brief introduction to several fields of psychology and psychotherapy. It discusses how psychological theory and technique can help financial planners better understand their clients’ psychology and provide better service, and improve client satisfaction and client retention.

Financial psychology

Although it is a large portion of this book and an important component of a working definition of client psychology, behavioral finance only scratches the surface of what psychology has to offer the financial planning profession. The broader integration of psychology into the world of personal finance has been termed financial psychology (Klontz et al., 2016). Financial psychology can be seen as an akin to clinical psychology, which “integrates science, theory, and practice to understand, predict, and alleviate maladjustment, disability, and discomfort as well as promote human adaptation, adjustment, and personality development (American Psychological Association, 2017b). Applied clinical psychology draws from the entire body of psychological theory and research to apply findings to alleviate maladjustment and promote adaptation in individuals and groups. Financial psychology draw behavioral finance and other areas of psychology to help alleviate financial stress and promote healthy financial behaviors.

Financial psychology focused on psychological research and theory to create micro-based techniques to help shape idiosyncratic financial beliefs and behaviors to improve financial health. These efforts go beyond cognitive biases and into the realm of a client’s idiosyncratic beliefs (e.g., money scripts) and financial behaviors (e.g., resisting financial advice, overspending, financial enabling, financial anxiety, etc.). Many of the numerous fields of psychology are of direct benefit to the financial planning profession. While we are unable to explore them all in this chapter, some examples of application to financial planning will be discussed as they relate to the fields of social psychology, developmental psychology, personality psychology, multicultural psychology, and positive psychology.

social psychology

According to the American Psychological Association (2017c), social psychology is defined as “the study of how individuals affect and are affected by other people and by their social and physical environments. There are many aspects of social psychology that can be and are being applied to financial planning. For example, it is important for financial planners to be aware of how their gender may affect the decisions of their clients. The gender of the financial planner appears to have a significant impact on the risk tolerance reported by clients (Grable & Britt, 2011). Specifically, men and women both report higher levels of risk tolerance when they are working with a financial planner of the opposite sex. Financial planners can also harness research from social psychology to improve their relationships with clients. Research shows that younger-looking faces are associated with a perceived lack of responsibility and immaturity (Zebrowitz & Montepare, 1992). However, younger financial planners can use aspects of social psychology to influence client perceptions (Klontz, 2014). One study found that wearing glasses can increase the degree to which others see someone as more trustworthy and intelligent, and if they are rimless glasses, they do not decrease the person’s attractiveness (Leder, Forster, & Gerger, 2011).

With regard to the physical environment, research has found that how a financial planner arranges furniture and the nature of that furniture can have a direct impact on a client’s level of stress (Britt & Grable, 2012). Additionally, the type of news programs being played in the financial planner’s lobby may influence their level of financial stress (Grable & Britt, 2012). These findings are important because the client-stress level has been found to be associated with their readiness to take action towards changing their financial behaviors and, subsequently, the success of financial planning (Britt, Lawson, & Haselwood, 2016). Implementing strategies to optimize the office environment, such as rearranging the furniture to create a living room feel and turning off televisions playing financial news may reduce client stress (Britt et al., 2016). If a financial planner’s office is optimized, the planner can expect that a client’s experience of stress will be lower and the effectiveness of financial planning enhanced.

Developmental psychology

It is human growth developed over the lifespan social, cognitive, including physical, intellectual, perceptual, personality and emotional growth” (American Psychological Association, 2017d). Whereas cognitive psychology looks at universal aspects of human cognition such as cognitive biases in behavioral finance (nature), developmental psychology takes into account the growth and development of the individual (nurture). For example, financial behaviors may change throughout one’s lifespan. As individuals get older, they may be more tolerant of risk within a financial planning context (Grable, 2000). Recently, aspects of developmental psychology and their relationship to financial planning have received increased attention. This includes the intergenerational transfer of money beliefs (e.g., Britt, 2016; Klontz et al., 2016) and the impact of financial events (Klontz & Britt, 2012) on the development of money beliefs and financial behaviors.

Money attitudes and values are formed early in life and affect financial health. Klontz and Britt (2012) found that attitudes such as money avoidance (“money is bad”), money worship (“more money will make things better”), and money status (“net worth equals self-worth”) are associated with disordered financial behaviors, whereas money vigilance (“money should be saved not spent”) acts as a protective factor and is linked to lower levels of credit card debt. The development of such money attitudes and related financial behaviors are based on observations of and interactions with caregivers during childhood (Britt, 2016). For example, involvement in savings and budgeting discussions with parents during childhood is associated with higher financial knowledge and well-being in adulthood (Shim, Xiao, Barber, & Lyons, 2009).

The manner in which one’s parents discuss money during childhood may also influence their financial decisions as an adult. Individuals who witnessed their parents arguing about money during childhood report higher levels of financial stress and higher credit card debt as adults, regardless of parental socioeconomic status (Allen, Edwards, Hayhoe, & Leach, 2007; Britt, 2016; Hancock, Jorgensen, & Swanson, 2013). To understand the financial behavior of a client, a financial planner may look to the financial behaviors of that client’s parents (Britt, 2016; Garrison & Gutter, 2010).

psychology of personality

As discussed in previous chapters, personality refers to “individual differences in characteristic patterns of thinking, feeling and behaving”  (American Psychological Association, 2017e). The psychological personality focuses on “understanding individual differences in particular personality characteristics and the various parts of a person come together as a whole (American Psychological Association, 2017e). Many theories of personality psychology have been applied to personal finances. These include personality as it relates to the psychodynamic perspective (Baker & Lyons, 2015; Trachtman, 2015), humanistic perspective (Johnson & Takasawa, 2015), dispositional/trait perspective such as the Big Five personality theory (Viinikainen, Kokko, Pulkkinen, & Pehkonen, 2010), and social learning perspective, including Albert Bandura’s social learning theory (Carrier & Maurice, 1998; Steed & Symes, 2009).

Various aspects of personality have been associated with a variety of financial behaviors as well as socioeconomic outcomes, including occupation, job performance, higher income, and higher net worth (e.g. Heckman et al., 2006; Mueller & Plug, 2006: Zagorsky, 2007). For example, conscientiousness—the personality trait of being careful or vigilant—has been found to have a direct influence on risk aversion (Nga & Ken Yien, 2013). Locus of control is another personality trait that has been shown to be related to a variety of financial behaviors and outcomes of interest to planners. Locus of control refers to the amount of control an individual believes they have over the outcome of events in their lives, and it has been found to be associated with income and net worth (Klontz, Seay, Sullivan, & Canale, 2014; Klontz, Sullivan, Seay, & Canale, 2015; Zagorsky, 2007) and a variety of money disorders (Britt, Cumbie, & Bell, 2013; Taylor, Klontz, & Lawson, 2017). It has been suggested that financial planners might benefit from assessing a client’s locus of control to see if the client might be at higher risk for problematic financial behaviors (Taylor et al., 2017).

Awareness of the influence of various personality traits on financial beliefs and behaviors can help financial planners tailor their approach to meet the needs of individual clients. It is also important to consider differences in personality predispositions within the client–planner relationship to avoid misunderstandings (Nabeshima & Seay, 2015). In addition, since personality traits can be altered through interventions (Borghans, Duckworth, Heckman, & Weel, 2008), it has been argued that “a deeper understanding of the financial psychology of high earners can help us, financial planners, better serve this population and better help individuals aspiring to increase their income and net worth” (Klontz et al., 2014, p. 52).

Multicultural psychology

Multicultural psychology has been defined the systematic study of how culture influences affect, cognition, and behavior . . . [it] is about how culture influences the way people feel, think, and act” (University of Rhode Island Department of Psychology, 2015). Culture is nuanced and includes the influence of “ethnicity, gender, age, nationality, language, religion, sexual orientation, socioeconomic status (SES), and disability status,” among other factors (Hays, Klontz, & Kemnitz, 2015, p.88). There is enormous diversity in beliefs, values, experiences, and norms across various cultures, and it is critical that financial planners are aware of how these cultural differences may shape their own and their clients’ decisions and the financial planning process as a whole.

Culture may affect the financial values and behaviors of individuals in many ways. In the United States, the financial planning profession is overwhelmingly comprised of European Americans, who tend to value personal independence (Falicov, 2001; Hays et al., 2015; U.S. Bureau of Labor Statistics, 2012). However, the United States is becoming increasingly ethnically diverse and the largest ethnic minority group, Latinos, tend to more strongly value “interdependence and shared financial responsibility among family members” (Hays et al., 2015, p. 89; Falicov, 2001; U.S. Census Bureau, 2015). Similarly, the European American culture tends to value assertiveness and verbal facility in professional interactions, whereas many American Indian and Alaska Native cultures often more strongly value subtle communication and listening skills (Hays, 2006; Hays et al., 2015). Other aspects of culture are important to consider as well. For example, individuals with disabilities face much more constraint in terms of financial security and planning than others due to less access to jobs and higher costs of living (Quilgars, Jones, & Abbott, 2008). In addition, individuals with a strong sense of faith may be more inclined to resist debt and “live within one's means” (Quilgars et al., 2008, p. 588). It is important for financial planners to be aware of how culture may influence their own financial values and beliefs as well as their clients.

positive psychology

Positive psychology emphasizes the study and promotion of constructs that do not just ameliorate problems, but promote thriving and enhance “what goes right in life” (Peterson, 2006, p.4). Findings from the study of positive psychology may assist financial planners in identifying the factors that promote the financial health of their clients. For example, a strong, positive relationship between one’s self-esteem and their decision to engage in financial planning has been demonstrated in research (Neymotin, 2010). Guven (2012) demonstrated a causal relationship between happiness and consumption and savings behavior. Happier people save more, spend less, and “seem more concerned about the future than the present” (p. 703). Positive psychology may also provide a framework from which to study the efficacy of financial planning. Irving (2012) suggests that the process of financial planning is potentially supportive of individual well-being. Financial planning involves assessing one’s values and setting goals for the future. Both the progression toward and attainment of goals is linked to improved self-concept, life attitude, and mood (Irving, 2012; MacLeod, Coates, & Hetherton, 2008; Sheldon, Kasser, Smith, & Share, 2002).

humanistic psychology

Humanistic psychology highlights the importance of the subjective human being with a focus on themes such as “self, self-actualization, health, creativity, intrinsic nature, being, becoming, individuality, and meaning” (The Association for Humanistic Psychology, 2017). Some of the basic tenets of Humanistic Psychology are that humans are inherently good, have a natural propensity toward growth in even the most adverse situations, and can thrive when a therapist provides an environment of authenticity, empathic understanding, and unconditional positive regard (Johnson & Takasawa, 2015). A focus on client communication and active listening is a primary intervention in Humanistic Psychology, which has been applied to the planner–client relationship in a growing body of financial planning books and articles (e.g., Bowen, 2011; Daniel, 2015; Klontz et al., 2016; Klontz & Klontz, 2016; Pullen, 2000). Motivational interviewing and experiential therapy techniques have also emerged from Humanistic Psychology, and have been applied for use in the planner–client relationship as techniques to help facilitate client behavioral change (Horwitz & Klontz, 2017; Klontz, Bivens, Klontz, Wada, & Kahler, 2008; Klontz et al., 2016).

Financial psychology For Financial planners

To make behavioral finance relevant to planners, an expansion into applied, practice-oriented psychology is needed. In the previous sections, findings from various disciplines of psychology have been briefly summarized and their relevance to financial planning has been demonstrated. For example, the impact of a client’s development and culture on their financial beliefs and behaviors has been explored. However, how can a planner use this information to help a client? Applied techniques adapted from schools of psychotherapy, such as cognitive-behavioral therapy, motivational interviewing, solution-focused therapy, or positive psychology, can assist planners in maximizing the financial planning process. These areas of psychology are perhaps the most useful for financial planners who want to take behavioral finance further and help individual clients identify, challenge, and change self-limiting beliefs and behaviors. 

Cognitive Behavioral techniques

Cognitive-behavioral therapy (CBT) is based on the theory that dysfunctional thinking—that which is inaccurate or unproductive—is the source of self-defeating behaviors (Beck, 2011). The way that is individuals perceive a situation is more closely connected to be their reaction than the situation itself” (Beck Institute for Cognitive Behavior Therapy, n.d.). CBT treatment is based on “a conceptualization, or understanding, of individual patients (their specific beliefs and patterns of behaviors)” (Beck, 2011, p. 2). As described in the previous section, an individual’s beliefs about money may be shaped by a variety of individual, developmental, and cultural factors, and specific money beliefs (e.g., money avoidance, money worship, and money status) are related to disordered financial behaviors. With an understanding of where unproductive beliefs and behaviors may have stemmed, financial planners can use CBT strategies to help clients change their unhelpful financial thoughts and behaviors and promote enduring improvement in their financial functioning and progress toward their goals.

Financial planners can apply CBT techniques to assist clients in identifying and reassessing “self-defeating beliefs that hinder or impede positive financial behaviors” (Nabeshima & Klontz, 2015, p. 145). Nabeshima and Klontz (2015) describe a scenario in which a client’s belief that she is “too dumb” to understand retirement planning is impeding her savings behavior. The process of restructuring irrational beliefs such as this one is typically completed in a series of steps:
(1) identify irrational beliefs, 
(2) challenge irrational beliefs, 
(3) test the validity of irrational beliefs, 
(4) create replacement beliefs, and 
(5) modify behavior (Beck, 2011; Nabeshima & Klontz, 2015). This process is generally a present-focused and collaborative experience that assists clients in developing coping strategies to deal with dysfunctional beliefs and implementing proactive behaviors to improve their circumstances.

To identify, challenge, and change problematic money scripts, financial planners may encourage their clients to keep an automatic thought record to track both their good and bad thoughts throughout the day. Referred to as a money script log (Klontz et al., 2008; Klontz et al., 2016; Klontz, Britt, Mentzer, & Klontz, 2011), this technique can be used as “a tool to help clients examine their thoughts, feelings, and unconscious thinking patterns around money” (Nabeshima & Klontz, 2015, p. 146). Clients are instructed to think about a financial situation that caused distress and record the emotion associated with the distress. They are then directed to identify the money-related thought, or money script, underlying that emotion and are asked to develop an alternative money script that will promote positive financial behaviors. CBT techniques have been shown to be effective in improving problematic money behaviors, including hoarding (Tolin, Frost, & Steketee, 2007), gambling (Toneatto & Gunaratne, 2009), and compulsive buying (Kellett & Bolton, 2009) disorders.

Motivational interviewing techniques

Motivational interviewing (MI) refers to strategies that people in the helping professions can use to increase a client’s motivation for change (Miller & Rollnick, 2012). It builds on Carl Rogers’ humanistic theories of an individual’s capabilities for change and is “a way of being with a client, not just a set of techniques for doing counseling” (Miller & Rollnick, 1991, p. 62). Specifically, MI is about “arranging conversations so that people talk themselves into change, based on their own values and interests” (Miller & Rollnick, 2012, p. 4). Financial planners often encounter clients who express resistance to change. In those instances, it is often the planner’s natural response to “provide more information, be encouraging, provide warnings, or confront the client” (Klontz, Horwitz, & Klontz, 2015, p. 347). However, research suggests that, when faced with resistance, this tactic often backfires and results in the client being less likely to change. Financial planners can utilize the key aspects of MI—partnership, acceptance, compassion, and evocation—to recognize client resistance and implement more productive behavior change tactics (Klontz, Horwitz, et al., 2015; Miller & Rollnick, 2012).

MI theory and techniques suggest that the financial planning process should begin with establishing trust. Britt et al. (2016) suggest noticing the temperature of your clients’ hands when greeting them. A cold or clammy hand may indicate stress, whereas a warm hand may indicate a more relaxed state. For clients experiencing stress, it may be particularly important to join them in conversation before beginning the financial planning process.  pending time in congenial conversation before diving into the subject of finances establishes rapport and increases trust, creating a foundation for change that can increase the efficacy of financial planning.

Financial planners can also engage in reflective listening to overcome client resistance and increase motivation for change (Klontz et al., 2016). Reflective listening is an active listening technique that involves a concerted effort to understand what someone is trying to say, even if he is not fully articulating it (Britt et al., 2016; Klontz, Horwitz, et al., 2015; Miller & Rollnick, 2012). When engaging in reflective listening, financial planners should avoid asking questions, as they can be perceived as confrontational. Instead, financial planners should interpret and summarize what their client is trying to say, “then reflect it back to them in the form of a statement” (Klontz, Horwitz, & Klontz, 2015, p. 351). A skilled reflective response confirms to the client that you understand them and that you are on the same page. It allows clients to continue talking, build on their thoughts, and develop possible solutions in line with their personal values (Britt et al., 2016; Klontz, Horwitz, et al., 2015; Miller & Rollnick, 2012).

solution-Focused techniques

Solution-focused therapy (SFT) “is a future-focused, goal-directed approach to brief therapy” (de Shazer & Dolan, 2012, p. 1). Its developers observed hundreds of hours of therapy and noted the questions, behaviors, and emotions that were most successful in facilitating client conceptualization and solutions. Financial planners can apply key SFT techniques to help clients reduce financial stress and make progress toward their goals. SFT techniques include: (1) recognizing and affirming pre-session change, 
(2) developing solution-focused goals, 
(3) asking the miracle question, 
(4) asking scaling questions, and 
(5) complimenting clients (Archuleta et al., 2015; de Shazer & Dolan, 2012).

Identifying Presession change occurs at the beginning of each financial planning session. The planner simply asks the client what changes she has noticed have happened or have started to happen since the last session or since she called to make the appointment for the session (de Shazer & Dolan, 2012). Recognizing and affirming pre-session change, even if it is small, increases the client’s belief that change is possible (Archuleta et al., 2015; Lethem, 2002). Financial planners should work with their clients to develop concrete, achievable, measurable, and solution-focused goals. That is, clients should be encouraged to frame goals as a solution, rather than the absence of a problem (Archuleta et al., 2015; de Shazer & Dolan, 2012).

Planners can use the miracle question to assist clients who struggle to articulate a goal. The miracle question asks the client to imagine what life would be like if, in the middle of the night, all of her problems were solved. The client’s response can guide the planner’s follow-up questions, which serve to understand the client’s values and identify small, manageable goals. After the client has developed goals, financial planners can use scaling questions “to establish the relevancy of goals and to gauge progress toward goals through the client’s eyes” (Archuleta et al., 2015). Scaling questions are popular in SFT due to their versatility. A financial planner can use scaling questions to measure a client’s progress toward or feelings about a variety of goals, events, or topics (de Shazer & Dolan, 2012). For example, a financial planner may ask the client to rate, on a scale from 0 (low/terrible/ not at all) to 10 (high/exceptional/goal is met), how well they are managing their money, how confident they are in their retirement plan, or how much financial anxiety they feel in various real or hypothetical situations (Archuleta et al., 2015; Britt et al., 2016). Financial planners can follow up by asking clients where they would like to be on that scale and what they have already done to help them move up the scale. Financial planners should offer affirmation of productive behaviors by complimenting clients on their progress toward goals, even if it is minor progress.

positive psychology techniques

A positive psychology framework focuses on not just how to alleviate or minimize problems, but how to promote and maximize thriving. It provides the opportunity for financial planners to move beyond maximizing returns and toward assisting clients in “maximizing the quality of their life as they define it” (Weber, 2012, p. 22). Positive psychology theory and technique has been adapted for use with financial planning clients. Asebedo and Seay (2015) make an argument for the overlapping goals of positive psychology and financial planning. They suggest planners might assess a client’s overall well-being in addition to their financial health and promote client well-being through the use of positive psychology exercises.

Applying positive psychology techniques to the financial planning process may start with asking, “How do we help our clients move beyond this basic financial security to accomplish those personal goals that make life worth living?” (Weber, 2012, p. 22). As such, rather than an exclusive focus on the external aspects of money, clients would benefit from an exploration of the underlying goals and values that motivate them to seek financial planning in the first place. One of these motivating influences is a desire to increase happiness. Positive psychology theory suggests that there are three levels of authentic happiness: positive emotions, engagement, and meaning (Seligman, 2012). Weber (2012) describes how financial planners can facilitate a process that works toward achieving each of these levels of happiness. First, planners may work with clients to create a financial plan that promotes positive emotions by ensuring income is set aside for activities the client enjoys, such as hiking, fishing, gardening, or going to concerts. Next, financial planners can encourage clients to be engaged with the present instead of focused exclusively on the future goal (e.g., a comfortable retirement). Planners can assist clients in doing this by using the techniques described above to assist clients in setting small, manageable, value-based goals along the way to their final goals. Research suggests that the process of goal setting, in addition to making progress toward and attaining goals, experiential techniques Similar to motivational interviewing, experiential therapy grew from the theories of humanistic psychology. Experiential therapy aims to balance the trust and relationship building of motivational interviewing with a more active, task-focused process of reflection on aroused emotions and promotes new and deeper meaning (Greenberg, Elliot, & Lietaer, 1994).

The “most central characteristic of experiential psychotherapy is its focus on promoting in-therapy experiencing” (Greenberg et al., 1994, p. 493). Klontz, Klontz, and Tharp (2015) describe “Experiential Financial Therapy (EFT), an integration of experiential therapy and financial planning” (2015). The application of EFT techniques has been shown to reduce psychological distress, anxiety, and worry about finance-related issues and increase financial health—improvements that were found to persist over time (Klontz et al., 2008).

EFT is grounded in the theory and techniques of psychodrama. It “has a strong emotional component and offers clients the opportunity to increase awareness of their feelings and sensations” (Klontz, Klontz, et al., 2015, p. 104). This is achieved through techniques, including and employing the use of role-playing, art therapy, music therapy, family sculpting, and mindfulness exercises. Financial planners can apply EFT techniques to their sessions by actively engaging their clients in these activities. The application of such techniques has been shown to increase the success of financial planning above and beyond traditional strategies. For example, a recent double-blind, randomized, controlled study investigated the effectiveness of two approaches aimed to increase the savings of 102 participants (Klontz et al., 2017). One applied a traditional, financial education–style approach (the control condition), while the other engaged the participants in experiential activities, such as guided imagery and the creation of vision boards. Results showed that at a 3-week follow-up, participants in the experimental group had significantly greater increases in their proportional savings (an increase of 73%) when compared to participants in the control group (an increase of 22%). In another study, using a 60-minute financial psychology intervention with experiential methods in retirement planning, meeting with three companies and a total of 198 employees, 401(k) contributions rates increased 39% (Horwitz & Klontz, 2017).

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