Making poor financial decisions is a common problematic financial behavior, and it’s a big topic. The decisions that we make about finances have really lasting consequences.
Most of these decisions fall into two general methodologies that produce quite different outcomes. One is more of a gut-based or emotions-based process, and the other is a more cognitive process. Gut-reaction decisions are usually the quickest and easiest decisions to make; more cognitive fact-based decisions are harder because they require data, things move more slowly, and it actually takes the body more energy to make these decisions.
This doesn’t mean that gut-based emotional decisions are wrong. In some cases they are very right. If you see a child in the middle of the street and a car is coming, you don’t have time to think about data like the speed of the car and how far away it is. You just dash out and grab the child, which is the right decision in that moment. However, for serious long-term decisions about our physical, financial, or emotional wellbeing, gut-based decisions don’t usually serve us well.
One problem with financial decisions is that most Americans think they know more about money than they actually do. I’ve written about the research behind this, including a study showing that 71% of Americans think they are financially literate yet, by age 40, 66% can’t correctly answer five basic fundamental questions on the concept of money. Other studies have reported that seven out of ten Americans have saved less than a thousand dollars in an emergency fund. Even for those with investments, 71% consider themselves passive investors, a label that is contradicted by their investing behavior.
Why is it that we’re convinced that we’re financially literate and that we’re passive investors, yet the data shows just the opposite? I think one factor, which is part of the human condition, is that facts don’t matter if they don’t align with our worldview. This is a big reason why so many of us hold onto delusional beliefs about money. We are really reluctant to undergo the arduous, painful, humiliating process of challenging and modifying our world views.
Inner parts of us were emotionally wounded at some point, often in childhood, and other inner parts stepped in with protective behavior meant to avoid ever feeling that pain again. With money-related issues, the protective behavior is based on money scripts that, despite their positive intent, are incomplete truths that do not necessarily serve us well in the longer term. Changing those ingrained beliefs is not easy—especially given that they are largely unconscious so we aren’t even aware of them. We just continue making gut-level financial decisions based on our money scripts, even if we are cognitively aware of data that tells us those decisions are not necessarily in our best interests.
How can you tell if you’re among the majority of Americans who think they are more financially knowledgeable that they really are? Look at your behaviors. Some red flags are having less than a thousand dollars in a savings account, buying and selling to chase gains with your investments, experiencing chronic anxiety about money, or feeling shame around your financial situation.
The first step in changing your money behavior is becoming willing to learn, becoming willing—perhaps with the help of financial therapy—to take a look at these parts of you that were so hurt. Even childhood experiences that may seem minor or may have had nothing directly to do with money can have a serious impact on your long-term financial wellbeing.
Check out The Financial Therapy Podcast by Rick Kahler concerning this topic.