How Do Financial Habits Form — And Can They Be Changed?

By Francis Bayes, Medical Student

Halfway into my third year of medical school, two types of patients have encouraged me to reflect on the following questions: (1) How do I have financial habits that others do not?, and (2) Can I change my habits when I need to? In this column, I share my reflections on how our habits are at the mercy of luck and our identity and if those habits can be shifted.

 

We Have to Get Lucky Twice

One type of patient who inspired this column is that person who has lost the genetic lottery. They have that disease-causing mutation that we have had to drill into our brain for licensing exams. They remind me that I could eat a healthy diet, exercise regularly, and have good sleep hygiene but still be diagnosed with cancer or a neurodegenerative disorder.

Another type of patient is that person who has lost the behavioral lottery. Humans tend to be resilient. But such patients had unfortunate life experiences that have shaped their maladaptive behavioral patterns. Once I recognized how my environments have prepared me to overcome stressors in my life, I refrained from passing judgment.

I do not mean to stir a discussion about nature vs. nurture with the above observations, as many patients fall somewhere in between. Likewise, we have been lucky to varying degrees with our financial health. In the following examples, what is the extent to which someone was born at the wrong time when it comes to our financial health and future?

1. John does everything right: he has read personal finance books, not paid too much attention to daily headlines, and saved adequately and regularly. But then a bear market begins with the most unfortunate timing, i.e., right before or after his retirement.
2. As Morgan Housel wrote about in The Psychology of Money, Jane might have an inappropriate risk tolerance (e.g., cash under the mattress or trading on margin) because her early experience of a stock market crash or a burst bubble has shaped her perspective.

With John, we might jump to say that he should have had less exposure to stocks and more to bonds. With Jane, we might predict that her risk tolerance will come back to haunt her. But we critique John and Jane as if changing or building financial habits—i.e., their spending and saving tendencies and behaviors–were easy.

An alternative explanation is that we were lucky, and they were not. If John were born five years later, he would still be working; if born five years earlier, his retirement portfolio would have grown well beyond his original target. John might have bought low-cost index funds of stocks every month for 30 years, because, as per his investing policy statement, he is a “buy-and-hold long-term investor in stocks.” How could he change his monthly habit and start buying more bonds and CDs just because he turned 60? Perhaps he thought, “I will keep buying stocks for one more month. Never mind, just one more year.”

If Jane started investing after reading The White Coat Investor’s first post in 2011, she would have been successful even if she took five years to digest his advice and implement a financial plan during the historical bull market.

If I started investing in 2020, I still might not have a financial plan and still chase speculative returns. I might have felt triumphant in February 2021 after months of proving the “experts” wrong and overcoming volatility. How could I have been persuaded that I needed to learn from the history of financial markets? I would have thought I was an investing savant until the bubble popped, whenever that might be.

 

Our Habits Change with Our Identity

To paraphrase Housel again, we underestimate the extent to which bad luck is responsible for others’ failure, and we overestimate the credit that we deserve for our success (and vice versa). The more we perceive ourselves to be deserving of our success (or failure), the more we reinforce our identity. The stronger our identity becomes, the harder it is to modify our habits when change is necessary.

For something as mercurial as investing, the less we identify it as part of our identity, the better it might be for our long-term success. James Clear observes in his book Atomic Habits (a review) that our identity drives our habits because “behavior that is incongruent with the self will not last.” John’s identity as a “buy-and-hold long-term investor in stocks” served him well until he retired, but he cannot implement a conservative portfolio unless he views himself as a “retiree who needs to withdraw from his savings.” Similarly, Jane acts according to her belief that she is a good trader, and even painful experiences might not help her realize that only a very few can be successful stock pickers. When John and Jane confront the risk that they could not see, it is too late to protect their capital because the market shifts faster than their identity can change.

But if bad luck has played a role in the development of financially inappropriate or unhealthy habits, we do not have to blame ourselves entirely for our failure. Because we were not born with such habits, we can also change them. For Jane, me, or anyone with human capital, it is never too late to learn and unlearn habits. James Clear shares his observation not to be a defeatist but to offer a solution. He encourages us to build “identity-based habits” by “acting like the type of person you already believe yourself to be.” For example, he shares:

“The goal is not to read a book, the goal is to become a reader.

The goal is not to run a marathon, the goal is to become a runner.

The goal is not to learn an instrument, the goal is to become a musician.”

These examples should be familiar to WCI readers. Anyone can say they want to pay off their student loans. But if they embody their identity as an attending physician, they are more likely to spend like someone with a six-figure salary instead of someone with a negative net worth. Instead, Dr. Jim Dahle has motivated new attending physicians to pay off their student loans by “living like a resident.” If they are proud of living like a resident, they can act according to their identity until they are free of student loans.

A Clear-Dahle remix would be: “The goal is not to pay off student loans, the goal is to live like a resident for 3-5 more years.”

 

We Need a New Identity for New Habits and Vice Versa

Building identity-based habits should not be considered as a “life hack” for only personal finance novices, because it is necessary at every stage of one’s journey toward and during financial independence.

An example: even though my parents are financially independent, they are reluctant to splurge when they are on vacation. I have reminded them that they are financially independent sexagenarians who do not need to support their adult children now or later. I want them to know that business-class flights befit their identity. I hope that each taste of luxury will reinforce their identity-based desire to prioritize comfort and new experiences over their tendencies as lifelong savers or their sense of parental responsibility.

In so many threads on WCI and Reddit forums, I have noticed that those who have been successful with their retirement savings still wonder if they are doing well enough. Even if one has paid off loans and is well on their way to financial independence, the extent to which they can be less anxious about their finances might be limited despite professional or communal assurance. They might have achieved financial success because they developed positive habits based on their parents’ examples or past mistakes, leaving enough time for compounding to work. But their financial habits might now be incongruent with what their spreadsheet (or accountant, financial advisor, etc.) is showing them.

Reading such threads is like seeing a reflection of myself in the future. Along my journey to financial independence, I may discover that I have financial habits that I should have shed a while ago. I might be editing transactions on Mint.com or searching for ways to boost my portfolio’s return. I might have trouble being more forgiving with my family member’s financial mistakes; more generous with my time and money to others; and more lenient with how much I spend for personal convenience. But I might have forgotten about how lucky I have been.

Without new habits, I will struggle to internalize my identity as someone who is fortunate to be financially independent. I will need to reflect on what kind of physician, investor, friend, and family member I want to be for the subsequent 10-30 years. Before my luck runs out, I should seek to become that person with my habits each day.

What kind of healthy financial habits have you formed? Have you been successful in changing your behaviors? Has your self-identity helped you or held you back? Comment below!