What influences our decisions about money: Part 1

Understanding the psychology of financial behavior can improve our overall financial health.

Behavioral Economics and the related area of study Behavioral Finances looks at the social, cognitive and emotional factors in decision-making. Basically, it is about trying to better understand why people make certain choices and in turn what can be done to improve those choices. Very often, people make choices which are based on familiarity or simply seem comfortable. The factors influencing our decisions are often more complicated and do not make a lot of sense from a rational perspective. So the more a consumer understands the basis of their financial decision-making, the more they can adjust their lifestyle choices toward a more healthy financial future.

Behavioral Economics teaches that the context, along with financial management knowledge and skills, have to be considered together. Financial Context is the mesh of actual circumstances and the way we think about and understand these circumstances. There is the fact of the matter and there is the manner of how we think about it, which is what Behavioral Economics addresses. Generally, this field of study creates behavioral models integrating psychological, classical and neo-classical economic theory to predict social purchasing models and marketing strategies. On a personal level, we want to be self-aware and understand that our financial behavior should express our best interest. This means that it takes more than having the skills to add and subtract or use a spread sheet to create and utilize a realistic household budget. How a person defines themselves, what process they use to make choices and if they can delay gratification are a few factors that influence a person’s relationship with money.

It is quite common that decisions regarding money are in fact irrational. For example a person may gamble on the lottery ticket, or spend less responsibly while on vacation than they would at home. Studies show that people often settle for less return instead of delaying gratification for a higher yield in the future. People continually promise themselves and others that they will start saving tomorrow, but then do nothing to alter their behavior. It’s important to understand that this pattern of irrational decision making is not limited to certain communities or income levels. It challenges all of us.

There are solutions to these behavioral conundrums. In the next two articles published on the Michigan State University Extension webiste, the key behavioral economic findings will be examined and options for addressing the challenges will be presented.

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