A look at common intersections of psychology and economic theory in the context of financial decisions of divorce settlements.
By Justin Reckers, Financial Advisor, and Robert H. Simon, Forensic Psychologist
The discoveries made since its founding in the 1970s have shaped how psychologists and economists perceive the science behind cognitive processes in financial decisions.
This article takes a look at common intersections of psychology and economic theory in the context of financial decision-making for divorce settlements.
Things to Consider When Making Financial Decisions of Divorce
1. The financial negotiations of divorce will be the largest financial transaction most individuals will ever participate in. The financial decisions made by our clients during and immediately after a divorce process may be the most important ones they will ever make and will determine the individual client’s feelings of financial comfort and security for many years to come, possibly for the rest of their lives.
2. Couples make plans together. Here are some examples from our practices working with individuals and couples navigating the financial negotiations of divorce.
- Couples may have decided one of the parents should stay home to raise kids at the expense of their career development. The end results in divorce are child support, alimony and retraining to enter the workforce outside the home;
- Couples often make a joint decision not to purchase Long Term Care insurance because they plan to care for each other in the event they need it. When they divorce the care-giver is lost;
- A couple may choose not to fund 529 accounts for college education because they can afford to pay the expenses from cash flow when they are both working. Divorce requires the support of two separate households and most advisors will tell clients college is a low priority when saving for retirement may no longer even be possible;
- A husband and wife team may choose not to save aggressively for retirement because the Husband expects a large inheritance and they plan to earmark those funds when received. In most circumstances an inheritance received after a divorce will only benefit one of the parties;
- A couple may decide to reinvest all of the profits from their small business back into growth instead of paying down a mortgage or saving for retirement. When it comes time for a divorce it is often not possible to turn that business into cash because a sale is not advisable.
3. Divorce is Anxiety Provoking, even Scary. The ambiguity of a now unknown financial future creates high levels of anxiety in clients navigating divorce. High Net Worth clients are just as anxious as the less financially fortunate. In fact. Losing half of $10,000,000 hurts a lot more than losing half of $500,000.
4. Ambiguity is rampant in divorce. Clients are often left without clear guidelines for what to do and how to manage things during the proceedings. They may struggle with whether to pay a mortgage payment for fear of the unknown consequences. They are advised by lawyers, friends and family members and the advice is usually different from one person to the next.
5. The financial Status Quo is always preferred. Most every divorcing person you would ever encounter will prefer things, at least financial things, to remain the same post-divorce as they were during their marriage. Reality is the paycheck doesn’t go as far when supporting two completely separate households so everyone loses financially in a divorce.
6. Trust is not easy to come by. It is common to see a marriage ending because of loss of trust related to deception. You would be surprised how often that loss has money as a main factor. Financial infidelity is more common than the average advisor knows. When a client loses trust in their spouse over money issues it often results in a costly effort to uncover hidden assets.
7. Hyperbolic Discounting is completely rational in the economics of divorce. People do weird things during and after divorce. We have seen people deliberately run a successful business into the ground to spite their former spouse. It is not uncommon for former spouses to go back to court every year to re-assess the appropriate level of spousal and child support payments. There is a very real possibility taking less, or paying more, today will turn into a far better deal than the alternative when your client incorporates the emotional and economic costs of ongoing litigation and ambiguity of the outcomes.
People’s financial preferences are often unclear or ill-informed when they are set in the midst of ambiguity and created by life experiences. An understanding of the intersection of human emotion and economic theory will help you as an advisor better serve your clients.
Understanding the client’s wants, needs, preferences, inclinations, and biases will allow you to help clients make economically “rational” decisions as they navigate the largest financial transactions of their lives set amidst the greatest emotional chaos they will ever experience.
Justin A. Reckers, CFP, CDFA™ is Chief Executive Officer of Pacific Divorce Management, a national network of financial advisors specializing in the financial intricacies of divorce and Director of Financial Planning at Pacific Wealth Management. www.pacwealth.com
Robert A. Simon, Ph.D. is a forensic psychologist, author, trial consultant, expert witness and alternative dispute resolution specialist based in Del Mar, CA. www.dr-simon.com
Because of the financial complexity of high-net-worth divorce, lawyers sometimes make mistakes when advising clients on their finances. Here are six financial mistakes to avoid during a client’s divorce process.