How the Psychology of Financial Planning Can Benefit Your Clients and Your Practice

Financial decisions are rarely made based on logic alone. According to a Capital One survey, more than three-quarters of Americans (77%) reported feeling anxious about their financial situation in January 2020. Since then, financial experts report that consumers’ financial stress has only gotten worse due to the global pandemic and subsequent record-level inflation, the latter of which ranked as a top stressor for 87% of Americans. 

 

“Extreme market volatility often causes people to take more risks than they should,” says Dr. Swarn Chatterjee, Department Head and Bluerock Professor of Financial Planning at the University of Georgia. “People tend to make the most errors when they anticipate losing money and as a result, it’s becoming more important for financial planners to be able to identify these psychological shifts and advise accordingly.”

An understanding of psychology has become increasingly valuable to professional financial planners. In 2021, CFP Board’s Practice Analysis Study found that to effectively understand the factors that guide clients’ behaviors and decision-making and respond to them with effective, actionable advice, financial planners must understand the psychology of financial planning. As a result, Psychology of Financial Planning became the eighth Principal Knowledge Domain and was first tested on the March 2022 CFP® certification exam.

To help financial planners better understand this new domain and to incorporate it into their professional practice, in April 2022, CFP Board released a new book, The Psychology of Financial Planning. This book is a resource to help advisors evaluate what drives their clients’ decision-making. Topics addressed in the book range from client values, attitudes and biases to sources of money conflict and crisis events — as well as planner attitudes, values and biases. The theoretical and practical knowledge provided in the book can help advisors shape better client relationships and deliver the truly holistic advice required to stay competitive.

How Is Psychology Related to Financial Planning?

Financial planning is an inherently emotional process for many clients. Creating and achieving financial plans involves identifying a client’s personal goals, and those goals are influenced by a client’s mindset and emotional behaviors. Financial planners must understand what the client wants and why — including the influencing factors — in order to evaluate all the paths that the client can take to successfully achieve their desired outcomes.

An understanding of this collective psychology — the client’s, the planner’s, and the influencing factors — facilitates better communication and better outcomes between the planner and the client.

Furthermore, financial planners must also recognize how their own attitudes, values and biases can impact their client relationships and services. An understanding of this collective psychology — the client’s, the planner’s, and the influencing factors — facilitates better communication and better outcomes between the planner and the client. This understanding can enable financial planners to ideate more solutions for their clients. As certain parts of financial services become automated, financial planners with a strong grasp of psychology can continue to differentiate themselves by providing the indispensable human element.

“Sometimes, clients spend money in ways that have nothing to do with their material needs and it’s important to assess where those impulses are really coming from,” says Dr. Dave Yeske, CFP®, Managing Director at independent wealth management firm Yeske Buie and Director of the Financial Planning Program at Golden Gate University. “To make progress with these clients, you need these crucial insights into the human condition.”

Improving Communication, Relationships and Results with the Psychology of Financial Planning

Effective communication is a cornerstone of financial planning. To achieve effective communication, you must gain your client’s trust by showing that you understand their goals and motivations. The client will feel comfortable sharing more information with you, helping you to create a plan that fits their needs.

“The quality of your client communication has a huge impact on trust and commitment,” Dr. Yeske says. “Clients have a much higher propensity to share financial information and motivations when they trust you, helping you to give more effective advice.”

“Financial planning is about people, and the psychology of financial planning equips financial planners with the skillset to build and deepen these relationships more effectively,” says CFP Board Managing Director of Professional Practice, John Loper, CFP®, MBA.

Clients’ relationships with others may also affect their financial situations. Clients may be confronting their emotions alongside their finances when facing divorce, eldercare, a terminal illness, a sudden inheritance or estate planning. Conversely, the way that clients approach their finances may complicate their relationships with others. Dr. Yeske shares that couples’ individual priorities are often not financially aligned, with the Institute for Divorce Financial Analysts finding that more than one-fifth (22%) of divorced U.S. couples surveyed cited “money issues” as their main source of conflict.

Financial planners trained in psychology can often get to the root of a client's financial troubles, helping them to establish healthier habits and goals for the future.

A financial planner trained in psychology adds greater value to the advice they provide to clients navigating these emotional mazes, according to Dr. Chatterjee. He shares, for example, that many clients treat inheritance differently than they treat their earned wealth, tending to take more risks on money they have not earned through work. With this insight, advisors can better detect behavioral patterns and work with clients to assess whether their short-term desires align with their long-term financial goals and values, in turn, helping them to use the new-found capital wisely.

Dr. Sonya Lutter, Herbers & Company Director of Research and Academy, notes that understanding the Psychology of Financial Planning gives financial planners the tools to intervene in critical financial situations that are not as often publicly discussed, such as a lack of transparency. A lack of transparency can entail financial infidelity amongst spouses, financial manipulation perpetrated by relatives, financial enablement or elder abuse. A comprehensive understanding of psychology can enable financial planners to spot the signs of financial abuse before their client begins to experience more severe consequences.

Dr. Lutter underscores the importance of treating all crises as equally important. “How we should approach someone whose spouse just passed is not necessarily different than how we approach somebody who lost their home in a financial disaster,” Dr. Lutter says. “Knowing how to recognize when it’s grief talking and bringing clients back into the engagement is paramount to addressing crises.”

Financial planners trained in psychology can often get to the root of a client's financial troubles, helping them to establish healthier habits and goals for the future.

“When it comes to wealth and how we use it, the financial planner must often engage in a values-based conversation,” says Dr. Yeske. “To be effective, we must inspire our clients to enact behavioral change.”

CFP Board’s New Book Can Expand Your Understanding of the Psychology of Financial Planning

CFP Board’s new book, The Psychology of Financial Planning, sets out to provide the theoretical underpinnings and practical knowledge for each of the topics that make up the new domain. This pioneering resource will help candidates prepare for the CFP® exam, and it also will help current practitioners improve their competencies in these areas.

“This book lays out the empirical research and simultaneously offers practical tools,” Dr. Yeske says. “It’s not enough to see the research, you need to have practical tools that financial planners can use in their day-to-day client work. This book does both.”

The book is organized into 15 chapters, divided into 6 parts that align with the 6 Principal Knowledge Topics that make up the Psychology of Financial Planning Domain:

1. Client and planner attitudes, values and biases;
2. Behavioral finance;
3. Sources of money conflict;
4. Principles of counseling;
5. General principles of effective communication; and
6. Crisis events with severe consequences.

Each chapter of The Psychology of Financial Planning book includes one or more case studies, with many based on real client interactions, such as navigating a client's risk tolerance and helping couples and families achieve greater financial transparency.

“All financial planning professionals would benefit from reading this book,” says Dr. Lutter. “Whether they’re certified, in the process of gaining certification, or not even planning to become certified, learning or refreshing their understanding of these concepts is vital.”

Understanding the factors influencing client mindset, behaviors and decision-making — and the complex interplay between client psychology and planner psychology — is key to dispensing the right advice and providing personalized service.

“From a therapy perspective, the first precursor to action is awareness,” notes Dr. Lutter. “Just reading and absorbing the knowledge in The Psychology of Financial Planning will almost surely have a positive impact on financial planners’ client relationships and practices.”

CFP Board’s new book, The Psychology of Financial Planning, is an indispensable resource that provides financial planners with the knowledge they need to integrate the Psychology of Financial Planning into their practices. The e-book and print versions are available now. Learn more on CFP Board's website at CFP.net/Psychology-of-Financial-Planning.