Personal finance generally is viewed as a numbers game: how much you earn, your investments, savings, expenditures, etc. However, while counting numbers is important for achieving financial success, the most important element is not the math, but how almost everything that you do relates to human behavior. This is critically crucial to help oneself with future wealth development. Your future investments, your mindset, and discipline are important in building wealth, but without the appropriate guidelines and discipline, you may find your future in extreme jeopardy. In this blog, you will learn why personal finance is dependent upon your behavior and how it impacts your everyday financial decisions.
This consequently gives rise to two key questions: (1) What constitutes behavioral impacts and finances, and (2) can improve one’s habits improve one’s financial condition? These questions can only be answered by comparing two examples: one with good spending etiquette and one person as a control group. Two people with very little income disparity tend to deviate from the norm when their expenditure habits are taken into account. Their spending, saving, and investing behaviors differ a lot, and thus their financial outcomes will be drastic in comparison.
We will explore why this drastic change occurs when only small and minute changes are employed in personal finance that lead to such unique outcomes in psychology, behavior, and mindsets. We will break down key principles, common pitfalls, and strategies to improve financial habits.
Section 1: Foundation of Financial Behaviour
Emotional Decision-Making (Impulse Spending)
Most of the financial choices are driven by our innate emotions. A few examples include:
- Fear leads to panic selling during economic downturns
- Greed encourages risky investments, such as in MLMs and other speculative cryptocurrency trading
These sorts of emotional decisions lead to poor financial decisions, which in turn reflect on a person’s bad habits. A person should only rely on themselves and make level-headed decisions regarding their wealth-building. Emotions should be under control during economic ups and downs so as not to over-invest and sell at an all-time low. If emotions are kept in check during times of crisis, it ensures a good financial outcome in the long term.
The Psychology of Delayed Gratification
Delayed gratification means choosing to pass up a smaller reward right now so you can get a bigger or better one later. All investments are made on this principle. Many experiments have shown that people who are less likely to resist this urge tend to do better in life later on. Resisting short-term spending to build greater wealth should be the goal. Many people tend to live paycheck to paycheck due to their poor spending habits, but abolishing that as soon as possible will only lead to more positive returns.
Habit Formation
Habit formation is why people do poorly in personal finances. They don’t stick to their good decisions and make poorly educated choices, which deteriorates their financial states even more. A good way to make your inadequate decisions more worthwhile is to use proper financial planning. Habits can take time to overturn and replace with more well-established routines, but it can indeed be done. It is in your hands whether your future financial state is determined by your ineffective decisions or your productive habits.
Cognitive biases
So far as we have seen, the behavioral aspects of human nature cloud judgment in financial decisions. Certain decision-making biases make these stand out more.
Relying on information sources that only confirm your pre-existing beliefs. For example, holding onto stocks that are subpar, hoping that they will be worthy later on.
Another common bias is basing decisions only on the first piece of information you hear. Overvaluing something on its initial price listings and investing in stocks that were once very good are examples of this.
Herd mentality is also one of the reasons why people tend to do worse in life. Following market trends that are nonsense will always lead to an impoverished result.
These biases lead to uninformed decisions, which can easily be avoided while also making adequate financial choices. So it is in your favour to avoid these as much as possible. This is proof of why behaviour impacts personal finances.
Section 2: Key Behavioral Factors
Saving & Investing Habits
Developing good financial habits is also key to financial freedom in the future. Saving a portion of your gratuity, whether pocketing it or investing it, is dependent upon you. But doing either of those will lead you to develop habits that are going to help you in the future. A mindset that allows savings to be automated is to start thinking of savings as a gift to yourself in the future. A good investment that lasts a lifetime is improving your habits.
Debt Management
A good way to start managing your debts is to classify them into two very distinct categories: good debt and bad debt. Good debt includes student loans and mortgages, which are investments in yourself. Bad debt includes credit card debts and vehicular loans, etc. These types of loans wreck your credit score and make you ineligible for future loans. These debts should be paid off first to maintain a good track record for financial institutions.
Debt management in the eyes of great financiers is the foundational step towards accumulating generational wealth.
Paying off your debt piecemeal is also a very ill-informed decision, as it only adds interest, creating an indefinite cycle of debt repayment that does absolutely nothing.
Spending Patterns
Excellent budgeting habits provide zero seepage into your finances. Those who do not overload on luxuries and live frugally or ‘on the cheap’ to enable themselves to live comfortably in the future will always have financial security. The feel-good purchases of emotional spending suck money from your bank account and rob you of your financial independence. Some people utilize credit issuance as credit cards to purchase wants; these are the ones who will regret their decisions in the future. Squeezing and budget-conscious decisions are financial habits. Choosing not to buy everything you want and living within your means is a smart move, and it’s something you shouldn’t be judged for.
Mapping Out Your Money Goals
One of the best pieces of financial advice you can give someone is to set S.M.A.R.T. goals! Specific, measurable, achievable, Relevant, and time-bound goals are one way of attaining financial independence in the future. Example: save $300,000 by 2027 so that you can pay for school and avoid student loans. To become financially independent in order to retire early, you have to implement a solid strategy. Focusing on long-term goals over short-term wants can speed up your path to financial independence.
Section 3: Typical Behavioral Deficiencies in Personal Finance
The Lottery Mentality
Building wealth takes time it doesn’t happen instantly. It takes hard work, persistence, and dedication. Expecting success to happen overnight is nothing more than wishful thinking. Any reliance on get-rich-quick schemes will only bring you failure and frustration. Gambling, speculative trading, or just plain eyeballing in finance will bring you complete failure. The lottery mentality is immature and should be avoided.
The remedy to this mentality is to only rely upon proven wealth-generating modalities, and plan both short- and long-range goals.
Lifestyle Creep (Diderot Effect)
Your wants should never be bigger than what your resources can support. Simply because you bought a luxury item does not mean you need to get them all. Lifestyle creep, coupled with peer pressure, is two of the first signs that someone will truly embarrass themselves financially. Controlling your wants and ignoring societal pressures will get you and keep you in a good place financially. This is how behaviour influences personal finance.
Limits on spending, good budgeting practices will help alleviate any ridiculous buying habits that may arise. Being intolerant of comparisons is another factor that aids in the improvement of financial habits.
Analysis Paralysis
Delaying financial decisions due to fear of making mistakes and overthinking is one of the most common shortcomings that leads to decision fatigue. Delaying retirement planning and investment will lead to fewer opportunities in the future, as most of them will have already long gone. A good solution is to stop overthinking and make small decisions. A small decision is better than inaction after all.
The Sunk Cost Fallacy
Holding onto failing stocks and investments, hoping that someday they will rebound, is one of the major bad habits that you may come by. Cutting losses early and making informed decisions in the future would help avoid this. Saying “I’ve already put so much effort into this” isn’t a smart reason to keep pushing a business that’s failing. As soon as an investment starts failing, cut it off and start anew. Fixing a sinking boat will only exhaust you more than swimming to the shore.
Overthinking/Procrastinating in Financial Decisions
Level-headed knowledge is required to make adequate decisions in anything, but overthinking and procrastination prove even more risky than investments not treated carefully. Personal finances are greatly dependent upon behaviour, which is precisely why it is way better for you to improve your bad habits than continue to either make no decisions at all or make so many ill-informed decisions that they ruin your finances.
Section 4: Improving Your Financial Habits
Creating a Financial Plan
A clear and carefully planned approach to your finances is crucial for hitting your money goals. Develop a percentage system for budgeting, like 50:30:20, which symbolizes 50% on needs (rent, food, and bills), 30% on wants (eating out, shopping, etc.), and 20% on savings. This is the perfect plan for financial success. A well-planned budget helps you cut spending and boost your savings.
An emergency fund should also be the norm for aspiring financiers. 3-6 months’ salary for an emergency is adequate. This will help you not rack up debt in times of crisis.
Spending Triggers & Self-Control Strategies
One of the best ways to avoid overspending is to have financial triggers for yourself. Thinking to yourself that you should be saving this money while shopping is the perfect mindset. Going out less often and, in general, budgeting your expenses will help rid you of all these bad financial habits. Controlling yourself through reward systems is also a great encouragement for saving. Setting up a savings goal through an S.M.A.R.T. system will help you achieve it in no time. For example, if I can save $2000, I’ll treat myself to a fancy dinner. This reward system will only prove beneficial in the future.
Education & Development
Making knowledge-based and informed decisions is only achievable through education in financial situations. Making good cash and cash-equivalent long-term investments can only happen because of market knowledge. Without education, and simply making decisions without foresight, will lead to losing money and discouragement to make financial decisions in the future. Obtain knowledge to better understand market tendencies, and therefore, be able to make more purposeful decisions to avoid poverty. Read books by people in finance. Check out books like Rich Dad, Poor Dad and The Psychology of Money to boost your financial knowledge. They are both books worth reading for financially responsible people.
Mindfulness & Emotional Stability
As we talked about in the previous section, emotional stability will also lead to more command over our decisions. But being mindful of what we are doing and reflecting on our previous financial mistakes will yield a more justified decision in the future. Taking a moment before making a big purchase can give you time to decide if you really need it. or simply how long it could take to save to purchase it. Try following the 24-hour rule: wait a full day before making any major purchase. You can also explore our article “How does a consumer know whether a purchase may be a good deal?” for helpful guidance.
Section 5: Real-Life Examples
The Thrifty Saver vs. The Lavish Spender
Let’s take a look at two people:
- Person A: Makes $60,000 yearly, invests 20%, and will be able to retire peacefully and early.
- Person B: Makes $100,000 yearly, spends it all, and only lives paycheck to paycheck.
The moment you realize that spending lavishly has its adverse effects, you start to do better and make well-informed decisions.
Emotional vs. Disciplined Investor
An emotional investor will panic-sell all his stock in an economic downturn and suffer heavy losses, while a disciplined investor will stay invested and make profits on market recovery.
Both have different behaviours in finances, but the disciplined investor will always tend to be more successful. This is the reason why discipline is so important in investing.
Conclusion
Your behaviour and how you behave are much more important than knowledge alone, and additional habits help to move your financial train towards success. If you can learn to master your behaviour and create good habits moving into the future, you will be in a much better position in the future than you believe you’re in. Your past, contingent future, and endless bad habits like procrastination, overspending, and monumentally thinking about an idea before executing it will surely create some financial problems. Good saving habits, controlled spending/budgets, and investing for the long term will create wealth that will endure.
Once you understand yourself and your challenges, you will be in a position to master financial habits.Managing money isn’t about how much you have it’s about how wisely you handle it. Wealth is measured by more than just dollars in the bank, which in factors down to three challenges for a person to manage. There is a terrific saying here:
Wealth is not measured by what you make, but by what you keep and how well you get it to grow smartly.
FAQs
Why Personal Finance Is Dependent Upon Your Behavior?
Personal finance is greatly dependent upon your behaviour. Emotions and cognitive biases severely impair your financial decisions. Discipline in investing, adequate budgeting, and debt management are all great habits that can affect your financial standing. Bad habits such as emotional decision-making and cognitive biases often result in financial struggles.
Understanding the 70:20:10 Rule in Personal Finance
This rule states that 70% of income should be spent on expenditure, 20% on savings/investments, and 10% on debt repayment. There are many great financial plans, and this is one of them.
What is the main reason for financial dependency?
The main reason for financial dependency is job loss in this market. The economy is a vast, uncharted sea of ups and downs. It is common for people to face business restructuring and lose their jobs. They become dependent on stipends from the government or their friends and family.
What is the Golden Rule of Personal Finance?
“Don’t spend more than you earn.” This has been the golden rule in finance forever. Avoid depending on loans to support your lifestyle, and aim to live below your means to achieve financial independence. Amassing credit card debt and relying on mortgages can be detrimental to your financial future.
What type of person is good at personal finance?
The type of person who’s good at finances is usually one with great problem-solving skills. It takes a great deal of knowledge to make bias-free decisions and take proper steps in investing your money and saving it.
