Behavioral Finance 101
Behavioral finance, simply put, incorporates and accounts for the messiness of the human experience.
It’s listening for what’s not being said. It’s about getting below the surface and the why behind the actions or behavior.
In the current market environment – this is when the rubber meets the road.
Users or clients can have all the plans in the world, but when downturns happen, the relationship with finance becomes a lot more complicated and emotional.
Users are saying: Wait a minute, this was not a part of the plan.
It’s called Money Psychology…
Our relationship with money is complex and deeply rooted in our psychological and emotional makeup. Our money psychology influences our financial decisions, including spending habits, saving behavior, and investment choices.
Think about your financial literacy. For many people, their understanding of money and finances is shaped by their upbringing and the financial habits of their parents or guardians. Unfortunately, if you did not have access to these financial tools and resources, it would have been a challenge to develop strong financial literacy skills.
Fintech is addressing money psychology by providing digital financial services that cater to our individual needs, preferences, and behavior.
For example, budgeting and financial planning apps use behavioral economics to nudge individuals toward making better financial decisions. These apps offer features such as automated savings, goal-setting, and spending analysis, which can help individuals manage their finances better.
So what are the mistakes users make that behavioral finance x fintech can help solve?
- Tunnel vision: We, as humans, tend to get fixated on an idea or plan, and we absolutely cannot deviate from it.
- Overconfidence bias: Believing that we are not prone to biases and somehow above having biases. (This fuels every other bias on the planet).
- Describing Happiness: People are generally poor at explaining what they want and have limited access to what can make them happy.
Now how do we solve these problems?
This is an area fintech x financial planning can help with a lot.
For example, Revolut has a budget planner for intelligent finance analytics.
The planner allowed clients to track how they spend money by automatically categorizing expenses. Based on the users’ spending behavior, the tool provided forecasts on their remaining budget.
The users can specify the sum they plan to spend each month, and the app calculates the maximum amount for daily spending accordingly.
And SoFi makes it easy to segment your payroll into different accounts based on categories (checking, emergency fund, travel fund, etc).
Next, it’s essential to use fintech to tie values to goals. This is something Dr. Daniel Crosby, behavioral finance expert, said is being worked on at fintech Orion.
Values sit beneath goals. If people have better access to what they value, those values give birth to the rise of specific purposes.
Let’s take the scenario of couples x money talk.
If a couple talks about money at the very beginning of the relationship, it’s more predictive of relationship satisfaction and divorce than how much they discuss cash down the road.
That’s because money talk points to a difference in values.
If you don’t get those values at the front, it will only compound and become more of an issue over time.
This is when education comes into play. And no, I don’t mean higher education or scrolling through TikTok.
2 types of education are critical to incorporating behavioral finance into fintech products:
- Meta Knowledge: Effectively knowing what you don’t know. For example, I know I have no idea how to build a fence. The fact that I know that means I will try and get help when I need a fence built instead of putting myself in danger.
- Just In Time education: Intervention at the moment when it’s most direly needed.
There’s this massive gap between knowing what we ought to do and doing the right thing.
That’s where Just In Time education comes into play. It helps us overcome the capacity constraints and ensures we are educated and ready at the point of a decision.
This is especially important during moments of stress.
When there is stress in the body, our brains are forced to make quick decisions based on emotions and habits. It’s also myopic because it’s not focused on the long term.
Application of these concepts into product offerings is a critical part of it.
If behavioral finance is not embedded within every component of your technology, it’s not helpful to anyone.
IMO, this applies whether you’re B2B, B2C, or B2B2C. Everyone is human.
What To Do?
Tech is so ubiquitous, and now tech is pervasive everywhere, that sometimes we can become unaware of its impact on us and our behavior.
Subtle tweaks lead to dramatic changes in behavior.
Look at Netflix: The “just keep watching” button after you’ve finished a show has increased viewing time by 70%.
And the average viewer isn’t even aware of having made a choice. Instead, they’re just whisked off to that next episode of Bridgerton.
This happens in fintech – for good and evil. Just look at what Robinhood’s nudging notifications have done to influence retail investing.
So one of the things that we have to do at the industry level is to make sure that our tech is built in a behaviorally informed and thoughtful way.
Let’s take a PFM application, for example. Consumers tend to mentally bucket their finances into multiple divisions: Safety net, savings, retirement, spending, etc.
So a simple solution is to add features that subdivide these accounts for users does a lot for their mental stability.
And naming one of those accounts something aspiration can 2.5x a user’s likelihood of saving.
Most healthy behavior comes along with a reasonably straightforward process and a personal touch.
It makes all the difference.
I want to share with you my toolkit…
That I’ve used to help educate myself, to whet your palette and get the philosopher inside your fintech brain working to make learning about this industry all types more fun, more creative, and, just plain and simple, more effective.
That’s why I’ve designed a new asynchronous course that highlights the impact that behavioral finance has on promoting a more inclusive and equitable fintech ecosystem, all while teaching a solid foundation about the principles, concepts, and laws that underlay fintech.
This course is perfect for those that want to:
🤑Acquire a foundational understanding of financial literacy.
🤑Gain a deep understanding of the fintech industry and its impact on the economy.
🤑Equip yourself with the skills to excel in today’s job market
This is your toolkit. I hope you use it!