Psychology in Finance, Audit & Risk
By Kim Stephenson, Author of Taming the Pound
Why is financial psychology important?
I want to give children and young adults the life skills to handle their thinking and emotions around money, and hence to achieve personal financial health.
As Psychologists, we say that we believe that behaviour, emotion, cognition etc. are important. As a society, over 100,000 of us signed a petition asking Government to make the teaching of personal financial skills compulsory, while over two thirds of UK Adults (70%)* have admitted to having debt problems. In education, "15% of teachers also admitted that they lack expertise in the area of financial education" (a).
So it appears that we as adults in society know very little about how to handle our own money in a safe way, desperately want our children to do better, but have few educators who know what to do.
And if 70% of adults are in debt and the nation is in the middle of an economic crisis, does it appear that even the financial “experts”, such as banks, financial regulators or economists really understand what is going on? (b)
One issue is a lack of basic financial skills, and as a former financial advisor (and qualified both as a diplomate of the Personal Finance Society and an Associate of the Chartered Insurance Institute), I am well versed in the basics. The mechanics of finance are actually very simple – if a six year old child can operate an i-phone she or he can certainly understand Annual Percentage Rates (APR) on loans, the concept of receiving interest on savings and the use of comparison websites (all of which are mooted as core learning for a “financial curriculum”.
But the bigger issue is that neither adults nor children have any concept of psychology. They do not know about deferring gratification (so they go into debt to buy things now, instead of saving up for it), they have no idea of the concepts of positive psychology (so they chase money for its own sake despite the evidence showing that materialistic values lead to unhappiness and that their underlying values and strengths, well used, could lead to happiness independent of money), they fail to plan and execute goals (they make “New Year Resolutions” to save money, that fail by the middle of February). Similarly, most adults have no concept of how they can change their own behaviour, relying on “will power” – one reason for the obesity epidemic as well as the personal debt crisis being a basic failure to understand concepts of behavioural change.
Teaching the basics of finance would help in some cases, but it is only by learning about the psychological mechanisms that make us act the way we do (why we spend money we say we want to save, why we are happy with our house or our car until we see somebody else’s that cost more, why we appear to have a happiness “set-point” and what it takes to move it) that we can really help the majority of people to take control of their personal finances and have a more satisfying and less stressful life.
And the first step in doing that is to educate children about the psychology of finance and how they can be in better control of their emotions and consequently their money, than their parents.
What has psychology got to do with audit or risk management?
I’ve now done a couple of talks and workshops for internal auditors – including for the Institute of Internal Auditors. You might wonder what I (or you) can offer them. Well:
As a psychologist you’ve seen the “gorilla” tape. People are watching basketball or juggling and counting passes, and they miss the guy in the gorilla suit who walks across the stage and waves at them.
In cognitive psychology, you did the experiments on the various visual illusions, the white square that isn’t there etc. You know people aren’t actually seeing reality, they’re seeing what they know is there.
From interview training, you know that people are cognitively economical, they make decisions, like “halo or horns” and then have confirmation bias.
As a psychologist you have read Gigerenzer, Pinker, Kahneman and know that a lot of out thought doesn’t work how we think, and from reading Gazzaniga you know that we can always find a post-hoc justification for any decision we made.
From Asch, Milgram and Janis, you know that people tend to conform, to be obedient and to agree with others who are like them. From interview training, you know that people like people who are like them and who see the world the same way.
So don’t you think you have a lot to teach auditors and risk managers – given that they are constantly making decisions on the basis of what they perceive (which isn’t true), their personal prejudices (that they don’t know they have), based on convention and the support of others (with out of date conventions and the support of an “in-group”), their failure to observe anything (like gorillas) that doesn’t fit their current mindset and that they are totally ignorant of this?
- (a) Research by Opinion matters, carried out online between 7/2/2012 and 10/2/2012 questioning 1,510 UK adult respondents
- (b) Survey of 258 secondary school teachers, conducted in December 2011 and January 2012 by Opinium Research
About the Author
Kim Stephenson is a Financial Psychologist, Coach and author of Taming the Pound. A Chartered Occupational Psychologist and qualified Financial Advisor,
Kim regularly speaks on the topic of the psychology of money, helps clients determine how they might change their behaviour with money and trains IFAs who wanted to understand and help their clients better.