All Personal Finance Books Are Fake

James Choi, a professor at Yale University, wanted to teach a different type of course on personal finance. He wanted his program to mix the conclusions of technical economics articles with the takeaways of glitzy bestselling books.

Several years ago, he started looking at dozens of popular personal finance titles, which had sold tens of millions of copies, to get a sense of the advice they provided. “I got really interested in this universe of advice and how was it different from the advice that we academics give on saving and investing, he told me. He realized that the most popular books tended to offer financial advice that was either starkly different from academic research or, in his words, “just plain wrong.”

Choi distilled 50 best-selling lessons on saving, spending, and investing and aligned them with the takeaways of mainstream economics research. This month, he published the results in a new article: “Popular Personal Financial Advice Versus the Professors”. His conclusion: Economists tend to offer more rational advice because they deal with numbers; bestsellers tend to offer more practical advice, as they grapple with human behavior, with all of its disorder and irrationality.

Perhaps the most striking example of the difference between economists and popular authors is advice on paying off debt. In economic theory, Choi said, households should always focus on prioritizing paying off their debt at the highest interest rate. Any other strategy is more expensive, because you just drag higher interest charges on your monthly bill.

But popular authors such as Dave Ramsey have suggested an almost opposite approach. According to Ramsey’s “debt snowball” method, you must pay off debt from smallest to largest, gaining motivation and momentum as you reset your accounts. It’s far from the cheapest strategy for eliminating debt – Ramsey admits. But his snowball method is not about technical efficiency. It is about developing the will. When debt-burdened people see a smaller account reach zero, it’s so rewarding that they’re motivated to keep paying off their larger balances.

Choi stressed that he doesn’t necessarily think Ramsey’s approach is strategically false, even if technically fallacious: “I think of this as diet and exercise. You can tell people to eat broccoli and steamed chicken all their lives. Or you can tell people about cheat meals to get them on board so they’re motivated to stick with the diet.

The focus of bestsellers on building momentum and motivation sometimes leads to less reasonable suggestions. For example, popular books frequently insist that people should save at least 10% of their income no matter what. You can think of this strategy as a way to “smooth out” your savings rate: rain or shine, you’re advised to store a consistent amount of income to build a savings habit over time. time.

But life is not smooth. It’s sharp. Many people who earn barely enough to pay rent at 25 become wealthy enough to easily afford a suburban home at 40. Some parents overwhelmed with child care expenses find a huge amount of money freed up when their children transition to public school. For this reason, Choi said, academics are more likely to advocate low, or even negative, savings rates for young people in anticipation of higher savings rates in their 40s. This is the opposite of smoothing your savings rate; it’s consumption smoothing.

These methods are more than competing personal finance strategies; they are almost like competing philosophies of life. Smoothing your savings pays homage to a psychological reality: habits require discipline and practice. While most people find it hard to suddenly change their savings behavior in middle age, it’s reasonable to advise them to make sacrifices when they’re young.

But consumption smoothing pays homage to an existential reality: life itself is the ultimate scarce commodity. The future is unknowable, and religiously maintaining a double-digit savings rate in life’s worst windstorms isn’t of the utmost importance. Having that special dinner with friends at age 23 is, for example, more valuable than having a few hundred extra dollars in your retirement fund at age 73. By this logic, building a budget that makes you comfortable and happy in the short term, even if it means varying your savings rate from decade to decade (or year to year), is best. approach.

This is perhaps the most profound conclusion of Choi’s article. Personal finance bestsellers succeed in blending theory and psychology in a way that takes human nature seriously and thus earns the respect of professors of economics. But those who spend their lives delaying gratification may one day find themselves rich in savings but poor in memories, having sacrificed too much joy on the altar of compound interest.

Perhaps many of the most popular books on personal finance could draw on economic theory: there’s more to life than optimized savings habits.