Self-Efficacy: The Key to Financial Success

In his long career at Stanford University, world-renowned psychologist Albert Bandura (1925-2021) greatly contributed to our understanding of human behavior and motivation. One of his main areas of focus has been the concept of self-efficacy, a person’s belief in their ability to succeed at specific endeavors.

In fact, Bandura’s research has demonstrated that self-efficacy is the most powerful determinant of an individual’s thoughts, feelings, behaviors, and accomplishments. He found that people with a strong sense of their capabilities 1) view difficult tasks as challenges to be mastered, 2) develop a deep interest in their activities, 3) set challenging goals and maintain a strong commitment to them, and 4) recover quickly from setbacks and disappointments.

In contrast, individuals with a weak sense of their capabilities 1) view difficult tasks as threats to be avoided, 2) quickly lose confidence and dwell on personal deficiencies and other obstacles to achieving desired results, 3) have low aspirations and weak commitment to goals, and 4) recover slowly from setbacks and disappointments.

Financial Self-Efficacy

Because self-efficacy has been shown to be a powerful catalyst for positive change, a number of researchers and educators have been exploring the connection between this psychological precept and higher levels of financial well-being. In fact, one researcher concluded that financial self-efficacy appears to be the missing link between knowledge and effective action.

However, it is important to understand that financial self-efficacy is not only influenced by one’s level of financial literacy and skills. A number of studies have demonstrated that several subjective factors—such as personality, family history, social and cultural norms, and frames of reference—also contribute to an individual’s level of financial self-efficacy.

Sources of Financial Self-Efficacy

According to Bandura, there are four major sources of self-efficacy: experiencing success, choosing good role models, responding to encouragement, and managing physical and emotional responses. Therefore, because self-efficacy is task specific, it is important to consider how these four strategies can be applied to personal finance and utilized to nurture and strengthen a sense of financial self-efficacy.

Experiencing Success - The most effective way to build a strong sense of self-efficacy is through performing a task successfully. One example from the world of personal finance is creating a plan to reduce spending and pay off a large credit card balance. The skills needed to manage cash flow and the discipline required to stick with the plan will inspire pride in accomplishment and motivate additional action steps toward financial well-being. In other words, successfully completing one important financial task will increase confidence in one’s ability to tackle the next one!
Choosing Role Models - Witnessing friends and family members successfully completing a money management task is another important source of financial self-efficacy. According to Bandura, “Through their behavior and expressed ways of thinking, competent models transmit knowledge and teach observers effective skills and strategies for managing environmental demands.” For example, if a respected friend talks about how he/she researched several auto insurance policies before making a purchase, this would likely influence others in his/her social circle to do the same type of thoughtful and effective comparison shopping.
Responding to Encouragement - Bandura also asserted that people can be persuaded to believe that they have the skills and capabilities to succeed. Therefore, hearing and accepting encouragement from others will help individuals to conquer self-doubt and to focus instead on giving their best effort to overcoming financial challenges and achieving their financial goals.
Managing Physical & Emotional Responses - Moods, emotional states, physical reactions, and stress levels can all impact how a person feels about their personal abilities in a particular situation. By learning how to minimize stress and elevate mood when facing difficult or challenging tasks, people can improve their sense of self-efficacy. For example, paying monthly bills can be an anxiety producing activity for couples that can create tension and touch off arguments regarding each other’s spending habits. However, mutually defining and committing to ground rules for financial conversations will help to facilitate respectful and productive communication, and lay the groundwork for creating shared financial and life goals.

Conclusion

Self-efficacy has been found to be an important attribute related to self-confidence and positive change in all areas of life—including personal finances. In addition, there is a growing body of research that suggests that financial advisors can help their clients build higher levels of confidence in their ability to engage in healthier and more productive financial behaviors. Dr. Derek Tharp, Assistant Professor of Finance, wrote:

Though it’s not a term many of us are likely familiar with, financial self-efficacy is an important concept for financial planners to understand and help promote in clients. Our clients’ confidence in their ability to carry out a financial behavior is ultimately a key driver of successfully implementing a financial plan.

“Reprinted by permission of Money Quotient, Inc.”