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All the personal finance books are wrong

All the personal finance books are wrong

James Choi, a professor at Yale University, was interested in teaching a different kind of personal finance course. He wanted his curriculum to mix the conclusions of technical economics papers with the takeaways from glossy bestsellers.

Several years ago, he began looking at dozens of popular personal finance titles, which have sold tens of millions of copies, to get an idea of ​​the advice they dispense. “I was really interested in this universe of advice and how it differed from the advice our academics gave us about saving and investing,” he told me. He realized that the most popular books tended to offer financial advice that was either vastly different from academic research or, in his words, “just dead wrong.”

Choi distilled 50 best sellers’ lessons in saving, spending and investing and aligned them with the takeaways of mainstream economic research. This month, he published the results in a new paper: “Popular Personal Financial Advice Versus the Professors.” His conclusion: Economists tend to offer more rational advice, because they deal with numbers; top sellers tend to give more practical advice because they grapple with human behavior—with all its messiness and irrationality.

Perhaps the starkest example of the difference between economists and popular writers was the advice to pay off debt. In economic theory, Choi said, households should always focus on prioritizing the payment of their highest interest debt. Every other strategy is more expensive because you just leave higher interest costs hanging on your monthly bill.

But popular authors like Dave Ramsey have proposed an almost opposite approach. According to Ramsey’s “debt snowball” method, pay off debt from the smallest to the largest, gaining motivation and momentum as you zero out your bills. It’s far from the cheapest strategy to eliminate debt—Ramsey admits as much. But his debt-snowball method is not about technical efficiency. It’s about building willpower. When people who are overwhelmed by their debt see a smaller account go to zero, it is so rewarding that they are motivated to continue paying off their larger balances.

Choi emphasized that he doesn’t necessarily think Ramsey’s approach is strategic wrong, even if it’s technically misleading: “I think of it like diet and exercise. You can tell people to eat broccoli and steamed chicken for the rest of their lives. Or you can tell people about dishonest meals to get their buy-in so they’re motivated to stay on the diet.”

The best salespeople’s emphasis on building momentum and motivation sometimes makes less reasonable suggestions. For example, popular books frequently urge people to save at least 10 percent of their income, no matter what. You can think of this strategy as “smoothing” your savings rate: Rain or shine, you’re advised to put away a consistent portion of income to build a savings habit over time.

But life is not smooth. It is prickly. Many people who earn barely enough to afford rent at 25 become rich enough to easily afford a suburban home at 40. Some parents who are burdened with day care expenses find a large amount of cash freed up when their children go to public school. For this reason, Choi said, academics are more likely to defend low or even negative savings rates for young people in anticipation of higher savings rates in midlife. 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. If most people are bad at suddenly changing their saving behavior in middle age, it is reasonable to advise them to sacrifice while they are young.

But consumption-levelling pays homage to an existential reality: Life itself is the ultimate scarce asset. The future is unknowable, and maintaining a double-digit savings rate through life’s worst mood isn’t of the utmost importance. For example, having that special dinner with friends at 23 is more valuable than having a few hundred extra dollars in your retirement fund at 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 the better approach.

This may be the most profound takeaway from Choi’s paper. Best sellers in personal finance succeed by blending theory and psychology in a way that takes human nature seriously and thus earns the respect of economics professors. But those who spend a lifetime delaying gratification may one day be rich in savings but poor in memories, having sacrificed too much joy at the altar of compound interest.

Perhaps many of the most popular personal finance books could take a page from economic theory: There’s more to life than optimized savings habits.

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