Psychology of Financial Literacy

Personal Finance and Psychology are opposites in that Finances are very logical and Human Psychology is anything but logical. For personal finances to be successful, rigid and repetitive behaviors have to be repeated over a lifetime. Human Psychology is much more dynamic and complex than that. If your goal is to attain personal financial success then you need to adjust your psychology and adapt it to the mechanics of money. This means identifying the facets of human psychology that inhibit correct financial actions and then managing them to allow correct financial actions to prevail.

One of the challenges in describing this is that everyone is affected by their own human psychology when it comes to money. It is especially hard to address the whole population when addressing financial psychology so here at thinkyourmoney we have tried to make our model as simple as possible so that everyone can understand it. One the one side we have the financial angels…your budget, balance sheet and your personal life plan. That is the financial side. The Psychology side includes 3 dynamic demons and 3 static demons taken from core knowledge of human psychology. Allow me to introduce you to our demons and explain.

I chose demons because demons can be caged, tied up, put in a bottle, frozen or otherwise disencumbered. Demons can also have a good side as well as a bad side. The dynamic ones are dynamic in that they change as you go through life.

There is a branch of psychology called developmental psychology. In particular it addresses how we develop through early childhood and adolescent years. There is not a lot of coherent literature after that point. However we identify 5 different developmental groups when related to financial behavior from early adulthood through to old age.

We believe that the key to financial coaching is in the developmental psychology demographics. If you follow the developmental psychology you will gain a great deal of understanding of what you should expect in your relationship with your personal finances.

• Birth to age 5 years old - Temperament is set by genetics and possibly womb time. All emotions are set by the age of 5 years old. That means that a big part of your survival mechanisms in life are set by the time you are 5 years old. You use your temperament and emotions to read and react to other people on every level of engagement in life. They are the core of your survival techniques. You do not grow out of how you behaved in the sandbox until you are in your 40s. I tell this to financial coaches and they have the epiphany that this explains a lot of bad behavior that they have witnessed. You would expect corporate presidents or those elected to positions of high authority to behave better but they don't. They are fighting it out just like the little kids in the sandbox.


• School age to young adult – Freud described that at this time in our lives we are driven by primal/survival needs. For survival you need food, water and protection from dangers. Adolescence and the coinciding release of hormones creates behavior that is bizarre at best and obnoxious at worst. Survival is very much a “me first” mode of thinking and if you think you are any more than this, it is only because you have been trained not to think this way. Denial is one of many techniques (cognitive biases) used to rationalize the bad behavior exhibited by this age group.


• 25 – 35 – the nesting phase – The urge to procreate is at its peak. The simplicity of it is that we are driven to procreate. The species survives because we procreate like bunnies not because we behave rationally. Emotions are the dominant psychology in decision making at this stage. Money is rational. At this point in your life you may think you are being very rational but the conflict between what you are trained and what you are feeling may not lead to rational decisions. Review your life and remember this time if you are in an older demographic. If you are in this demographic understand that the coaching you get will be so that you do not waste your financial resources like previous generations did during this phase in their lives. During this phase you will make decisions that you will not necessarily agree with as you move into the next 10 to 20 years of your life.


• 35 – 45 – the crash and burn demographic – This is the age demographic where both the mean and the average for divorce and bankruptcies spikes significantly. By that I mean that by far more people divorce or go bankrupt during this phase of their life compared to any other. The proof is in government published statistics. On a psychological level any counselor will tell you that your rational self is awakening. It comes alive and you rethink past decisions (made with emotions as your guide) and you decide which decisions are “keepers” and which need to be changed. The feeling is that you wake up one morning and you say to yourself that you “just can’t do this anymore”. You cannot continue to engage in irrational behavior or behavior that causes you distress to sustain status quo. Things must change to become acceptable to the emerging sane and rational part of your personality. There are some casualties but it usually works out for the better.


• 45+ - rebuild and plan for retirement – Hopefully you have shed the burden of irrational behavior and you can now connect with the rationality of the Big 3 financial tools to rebuild your life and your personal finances. You are at your peak earning years and hopefully the kids are becoming independent. You may end up helping parents and become a member of the sandwich generation. You can make the sprint to the finish and mold your finances to support your financial needs in retirement. You have the experience to know what works and does not work and a mind relatively free of primal drives. This actually allows you to take care of your finances better than at any time in your life. We will try to show you how to make the best of it.

Through these age groups the Freudian concept of Id, Ego and Superego are particularly busy. The Id is your basic needs and desires such as food, status, attention and sex. This is particularly out of control in your youth and training and seasoning are required to keep these desires in check. In this case your Ego is the training by your parents, mentoring by those you trust and coaching by those in authority that help you manage to get in touch with the logistics of money and control your Id’s undisciplined ways. Later your own capacity to make rational decisions becomes the strongest part of your personality and that is your Superego.

This development is another way of describing Developmental Psychology especially for our discussion. The Id dominates your youth and early adulthood. Parental guidance and training help you manage your relationships through the challenging early years. Then your rational self...your superego takes over in the later demographics.

Now here is the kicker. 90% of the time you have no idea that this battle is going on inside of your Financial Personality. This is because your awareness is divided between your conscious and your subconscious mind. Only 10% of what is going on is in your conscious mind and that is usually the logical part. Especially in your youth you have no idea how much you are influenced by basic survival instincts hidden in your subconscious Id.

The static demons are more stable. They are what they are for life. The only way to get past them so that you can manage your money rationally is to understand them and then develop management strategies to deal with them.

IQ was developed as a measuring stick for intelligence. It has some cultural biases but it outlines the truth that we are not all created equally when it comes to learning. Rational thought does not come easy to humans as our dynamic demons get in the way. So do our static ones. This one especially can impair the capacity to rationally manage money. 50% of the population has an IQ under 100. Legal contracts are all written and understood by those with IQs much higher than 100. The personal finance playing field is tilted in favor of those with a higher IQ. This is simply undeniable.

The human psyche is flawed. Like our bodies where there is every sort of disorder and disease, so it is with our psyche. Some mental disorders such as depression can come and go like the flu. Others such as Schizophrenia stay with us for life. Others such as addictive behavior infect as much as 33% of the population and affect 100% of us in some way or another. In all cases these behaviors need to be identified and treated by trained professionals. In a worst case scenario the diagnosis may include a prescription that those afflicted by some of these disorders just need to have their personal finances taken care of by someone who can manage them in accordance with the rules of money. The person diagnosed just cannot.

We are a social animal. We live in structured groups and status within the groups is like a pecking order. To help us cope with lower status or our incapacity to perform in the group we have a set of behaviors call Cognitive Biases. Simply stated these are variations of 106 lies that we tell to ourselves and our group to cope with our interactions within groups...particularly the ones that are not so successful. In the case of personal finances some of these are used well and often both by marketers and by persons justifying their lack of personal financial competence.

We all have a different Personal Financial Personality. Look at all of this stuff buzzing around in your head. No wonder you can only have 10% in your conscious mind.

To help you with the challenges of sorting this out you have some heroes who can come to your rescue. Our 3 Financial Literacy heroes are Financial Mentors, Financial Coaches and Financial Therapists. What really complicates this is that they have their own challenges when it comes to their own personal financial personality.

We think that you need to separate the 2 parts of Financial Psychology. See the Heroes that deal with finance to deal with your personal finances. Have them help you understand your budget, your balance sheet and your personal life plan.

On the Psychology side see the Financial Therapy Heroes that deal with Psychology so that you can deal with your demons first and get them under some control. That frees your conscious mind to deal with your personal finances using the Big 3 tools of Personal Finances.

This solves the problem that most financial mentors and coaches have their own demons to deal with. Similarly most therapists have their own demons to deal with and most have their own financial challenges. This approach allows them to stay within their training and help you with what they know. Using both sides of the equation you will free your mind to think logically about money to get what you want from your own agenda.