I never could have imagined how important managing emotion, cognitive biases and behavioral hurdles is to saving enough, spending wisely and managing financial risks. For about a year, I informally coached a woman (we’ll call her “Leigh”) in her late twenties who wanted to eliminate the $5,000 of expensive credit card debt she was rolling over each month, build a rainy day fund and begin saving for retirement. I have to admit: I learned more from her than vice-versa.
“Yes, the numbers need to work, but more importantly your LIFE has to work. You won’t stick to a plan if it defies who you are.” — Sarah Newcomb, Senior Behavioral Scientist, Morningstar
Willfully ignorant of my own decision-making weaknesses, I believed that managing money was the domain of logic and math: maximize your risk-adjusted returns, match your risk tolerance, save aggressively and minimize your expenses and trading. My work with this client highlighted the behavioral psychology of money. You can use these observations to better manage your own financial behaviors.
- Identity and agency: Nearing age thirty, which to Leigh means a family with children, it was time for her take responsibility for the past and prepare for her future. We often spoke about aspects of her financial life that were within her control. We discussed the psycho-emotional needs that her spending met and crafted strategies to meet those needs cost-effectively.
- Construal level: We often discussed getting older, plans for the future and retirement in vivid detail to make it more concrete and salient to motivate her to save a bit more.
- Mental accounting: At the outset, Leigh had a large credit card balance and a smaller savings balance. She hadn’t realized that the credit card balance was essentially financing a much lower interest rate in a bank savings account, since they had different purposes.
- Selective attention and limited bandwidth: Traditional budgets are not for everyone: Leigh was not one to track every dollar spent. Indeed, she usually ignored Mint’s budget update emails. We instead set up an automated process of paying the first dollars of each paycheck to debt repayment or savings. The rest was available to spend that month.
- Mindfulness: She also found it effective to be more mindful and non-judgmental of each transaction. She took to reviewing her spending during a weekly calendar appointment she made with herself. She identified unnecessary ride-share spending, which motivated her to cut back somewhat.
- Goals and measurement: My client’s goal was to accumulate three months expenses (the estimated amount of time to find a new job, should she be laid-off) in savings plus paying off all her credit cards within a year. We measured her net worth monthly, so she could see how her discipline and deferred gratification were getting her closer to her goal. It also made it possible for her (and me) to hold herself accountable when progress was slower than planned.
- Self-control: Leigh would occasionally fall off the wagon, buying furniture or a vacation before saving enough to pay in cash. Financial wellness is a habit that takes time; a rigid application of financial rules would have surely backfired. As her coach, I had to remind myself to bite my tongue and take the long view.
- Resilience: My client experienced a setback when an old mistake resurfaced in the form of a major, unexpected expense. Having a plan, which she was making progress on, as well as a sympathetic coach, helped keep her on track. Fortunately, she was able to negotiate a slightly reduced obligation and payment plan.
- Stress. Leigh engaged in some retail therapy in part because that setback occurred when work and school were particularly stressful, reducing her self-control. Perhaps actual clinical therapy or other form of self-care would have been more effective.
- Loss aversion: She received a salary raise while I was working with her, which was a good time to increase savings (by half of the raise). The raise lessened the perceived loss of increased savings and got her to her goals faster.
- Limits of technology: It quickly became clear to me that an app, even the one I had lovingly built over three years, would never be sufficient to keep Leigh motivated. She needed a human to empathize with and hold her accountable, address unpredictable questions and situations. My experience with our start-up suggests this may be true of most people.
In sum our saving, spending and investing decisions either reflect our personal values or they’re the result of behavioral challenges and cognitive biases I described above. My experience with Leigh suggests that being mindful of the psychological aspects of financial wellness can bring better results. In this case, her net worth is already well over $10,000 and she has begun investing in her retirement, putting her ahead of more than half of her peers.
This article originally appeared on March 12, 2019 at Forbes.com.