Three years ago, Yale SOM’s James Choi was planning a new course on personal finance. It seemed natural to consult a few popular books on the subject to see if they might contain any useful material.
But when he delved into the bestselling headlines, “I was surprised at how much some of the advice was at odds with what we as economists think is the right thing to do.” ‘after economic theory,’ he says. The experience “planted a seed in my mind: wouldn’t it be interesting to do a systematic survey of what this book market asks readers to do?
Over the next few years, and with the help of a small army of undergraduate research assistants, Choi did just that. He picked the 50 most popular personal finance books on Goodreads and, in a new article, listed their advice on issues such as mortgages, savings strategy, debt management and investment allocation.
Unlike most economic models, personal finance gurus focused intensely on how psychological factors such as willpower and motivation play into financial decisions.
In some cases, the advice was simply incorrect. But much of it deviated from economic theory in ways that Choi found harder to diagnose as directly good or bad. Unlike most economic models, personal finance gurus focused intensely on how psychological factors such as willpower and motivation play into financial decisions.
For example, many books advocated saving 10-15% of your income, regardless of your income. Economists, on the other hand, would argue for consumption smoothing, that is, keeping spending constant over time and saving more as you earn more.
“Economic theory says your savings rate should be low in your 20s and very high in your 40s to compensate for the fact that you don’t save much in your 20s,” says Choi. From this perspective, not saving much in your post-school years is “perfectly fine, and in fact optimal.”
Still, he understands why personal finance books don’t recommend this strategy. “I think it comes from a different conception of human nature,” Choi says. These authors view saving as a discipline, so the sooner you establish the habit, the better. Developing the will to save is “not a problem for the fictitious economic agent in our models”.
(Here, notes Choi, economists may be guilty of a “do as I say, not as I do” approach. modest income. “Definitely yes,” Choi admits.)
For popular authors, psychological factors occupy an equally important place in the approach to debt. If you have multiple loans competing for your repayment dollars, economists would argue for paying off the highest-interest debt first. Amazingly, 10 of the books Choi read advised against this seemingly indisputable strategy. They suggested paying off loans with the lowest balances first – the so-called snowball strategy – not because it’s mathematically sound, but because it gives over-indebted borrowers a much-needed win. . Choi doesn’t quite agree, but sees the logic: if you’re feeling overwhelmed, zeroing out an account “could be super motivating.”
In general, many popular finance books have taken a stance on debt that contrasts with the more neutral outlook of economists. “Books almost universally say it’s a terrible idea for you to have credit card debt,” Choi says. “Only one of the books, by Suze Orman, said it might be okay for you to have credit card debt if you’re just starting out in life and expect your income to be significantly higher in near future.”
Choi also observed a strong divergence between economists and popular authors on the subject of mortgages; 11 books have called variable rate mortgages riskier than fixed rate mortgages. That’s not always true, Choi points out. Fixed rate mortgages are very sensitive to inflation unlike variable rate mortgages. “Economic models say most people should prefer a variable rate mortgage unless they’re really increasing their budget to buy the house or interest rates are very low right now,” says -he. “And that’s the opposite of the message you get from popular authors.”
Ultimately, whether the advice offered by popular finance books is good or bad, Choi considers it important to understand. “They affect a ton of people. Millions and millions of people are paying a lot of money to read these things,” he says. “And, frankly, those authors are probably more influential than economists.”
“Perhaps as economists we should reflect on what is missing from our advice. Maybe there are things people really care about that we don’t factor into our models.
The very fact of these authors’ popularity suggests that “people find their message somewhat compelling,” Choi says. “And so maybe we as economists should think about that and say, hey, what’s missing from our advice?” Maybe there are real constraints that people are under, or things that really concern them, that we just don’t take into account in our models.
It’s clear to Choi that there is a need for accessible, easy-to-follow, and accurate advice from trusted sources. Many people reach their early twenties with little knowledge of how to manage their finances, so turning to popular books for advice is an understandable choice. He thinks universities could help fill the void – most don’t offer personal finance courses, but when they do, “there’s overwhelming demand”.
And if you’ve followed the wisdom of popular personal finance gurus — especially the pro-savings, anti-debt contingent — instead of economists, Choi sees no reason to panic. Their guidance may not always be theoretically optimal, but it’s usually not ruinous either. After all, “it’s safe to live within your means and not borrow with your credit card,” he says. “That’s not crazy advice at all.”