Three Key Steps to Financial Awareness
Posted by: Joseph Kuo | February 22, 2021
For many of us, managing our finances and building economic security is a nagging concern. We generally know that we should be putting in more effort towards managing our money matters. But more often than not, very little actually changes. What keeps us from achieving the financial life we desire? What are some simple things we can do to get started?
Reflect on Your Money History, Beliefs, and Patterns
One of the main obstacles to financial freedom is listening to the wrong money messages. Our current attitudes and beliefs about money often have their roots in our past formative life experiences.
A fundamental component of financial emotional awareness is introspection. Introspection is the ability to be honest regarding past experiences that have shaped your current relationship with money, and to use that knowledge to clarify your financial goals and manage your financial risk tolerance.
We can start by looking for clues in your past that will help you to understand your current financial life. Starting with your childhood, what experiences shaped your underlying beliefs and attitudes about money? What do your patterns of earning, saving, investing, and giving tell about you?
A review like this will give you tremendous insight into the money messages that consciously and unconsciously influence how you currently deal with money issues on a day-to-day basis. The point of these revelations is not to place blame, but rather to help you recognize some potential obstacles to your financial well-being. Remember, recognition is the first step to change.
Clarify Your Financial Goals and Priorities
Goals are targets—something to aim for. They give life direction. Setting goals is an activity that is essential to maximizing your potential and provides many other benefits as well. Setting goals can:
- Provide a positive expectancy of the future.
- Stimulate your personal growth and development.
- Help you to “keep your eye on the prize” and give you the needed motivation to bounce back from setbacks and disappointments.
- Facilitate “future thinking”, a way of looking ahead to anticipate future needs and wants.
- Give you a framework for making decisions.
- Help you take control of your life by carrying out your own agenda, and not one that someone else has set for you.
But most importantly, keep in mind that goal setting is an effective way of picturing what you want to achieve and what you want your life to be like. When you have that picture firmly in your mind, then you can start making meaningful progress towards that goal.
Assess Your Risk Tolerance
Risk is defined as the chance of experiencing loss. In regard to financial decision making, we all mentally calculate the risks and rewards we are likely to experience. Some of us focus more on the potential losses (risks) and some of us focus more on the potential gains (rewards).
When you make a financial decision, do you intentionally weigh the potential risks versus rewards? Is weighing that balance more of a rational or emotional process for you? In other words, do you tend to rely more on facts or on feelings?
With respect to investing, when someone asks you about your risk tolerance, they are really asking you about your emotional response to the possibility of loss and the possibility of gain. At one extreme are those individuals who are averse to risk. They focus their thinking on the “worst case loss” part of the equation. For them, risk causes anxiety and thus is to be avoided. Such investors want to stick with the known and predictable. They value financial stability above all else, and are willing to sacrifice higher returns to achieve that stability.
At the opposite end are those who are addicted to risk. They focus on the “maximum potential gain” part of the equation. For them, risk is exciting and alluring and the potential for financial reward is irresistible. In order to “get rich quick”, they are willing to gamble with their money.
These two cases are the extremes. Individuals at either end of the risk continuum operate more on feelings than on facts. Those who are either averse or addicted to financial risks are operating in economic “danger zones” and both extremes potentially jeopardize long-term financial security.
Either way, knowledge is the antidote for overcoming the emotional responses that can sabotage sound investment decisions. To raise your financial awareness (“money quotient”), it is important to seek the appropriate level of risk for you and to commit to becoming a calculated risk taker. The calculated risk taker does not avoid risk or exploit risk, but learns to manage risk and use it to their advantage.
To become a calculated risk taker, you must first become aware of the underlying emotional motivators that repel you or draw you to financial risk. The next step is to educate yourself so that you can replace irrational reactions with rational decisions.
Here are some essential topics to help you get started on becoming an effective manager of financial risk:
- Basic differences and similarities between common savings and investment vehicles: savings accounts, money markets, certificates of deposit, bonds, mutual funds, and stocks.
- How to categorize savings and investment vehicles as cash equivalent, income producing, growth producing, or speculative.
- How to match savings and investment vehicles to financial goals: short-term goals to cash equivalents, mid-term goals to generate income, and long-term goals for growth.
- Spread savings and investment dollars across all categories and in a variety of savings and investment vehicles. Only investment dollars you wouldn’t mind losing should be in high-risk investments.
The following questions will guide you as you think about and assess your financial risk tolerance.
- When you are making a financial decision, whether it’s a major purchase or a weekend expense, do you feel you consciously weigh the pros and cons?
- In weighing the risks and rewards of a financial decision, is that more of a rational or emotional process for you? In other words, do you tend to rely more on facts or feelings to help you make your decision?
- In regard to making financial decisions, do you tend to be risk averse or risk addicted?
- Do you tend to swing back and forth between risk averse and risk addicted depending on what kind of financial decision you are making?
- Do you feel it is important to align your financial attitudes and behavior with the mid-range (calculated risk taker) on the risk tolerance continuum?
- If yes, what steps do you plan to take to bring your attitudes and behavior to that range? If no, what are your reasons?
Financial emotional awareness requires introspection about the formative experiences that have shaped your financial world view, as well as recognizing and learning how best to manage your personal financial risk tolerance. Becoming more aware of the differences in risk between different types of investments and being aware of your personal financial risk tolerance will go a long way towards financial awareness, and ultimately, financial well-being.