In my defense, I didn’t get into financial trouble immediately after my master’s degree in economics. It took months. I had a decent paying graduate job and was living within my means, so how did that happen? Simple: I “cleverly” put all my savings into a 90-day notice account to maximize the interest I earned. When I was caught off guard by my first tax bill, I had no way of meeting the payment deadline. Excuse me.
Fortunately, my dad was able to bridge the gap for me. He had no training in economics, but three decades of additional experience taught him a first-hand lesson: Things happen, so it’s best to keep some ready cash in reserve if you can. This was not the first collision between the formal economy and the school of life, and it will not be the last.
James Choi’s academic article “Personal Money Advice Celebrity Versus Professors” caught my eye recently. Choi is Professor of Finance at Yale University. It’s traditionally a formidable technical major, but after Choi agreed to teach an undergraduate class in personal finance, he plunged into the market for popular financial self-help books to see what instructors like Robert Kiyosaki, Susie Orman, and Tony Robbins had to say on the subject.
After scanning more than 50 of the most popular personal finance books, Choi found that what the Ivory Tower advised was often very different from what was told by tens of millions of readers by finance experts. There have been occasional outbreaks of agreement: most popular finance books prefer low-cost passive index funds to actively managed funds, and most economists think the same. But Choi found more differences than similarities.
So what are those differences? And who is right, teachers or professors?
The answer, of course, depends on the teacher. Some operate on the risky schemes of get-rich-quick, the power of positive thinking, or hardly give any coherent advice at all. But even the most practical books of financial advice deviate strikingly from the optimal solutions that economists calculate.
Sometimes popular books are simply wrong. For example, a common claim is that the longer you hold stocks, the safer they are. incorrect. Stocks offer more risk and reward, whether you hold them for weeks or decades. (Over a long period of time, they’re likely to outperform bonds, but they’re also more likely to spell disaster.) Still, Choi believes this misstep will do little harm, because it yields sensible investment strategies even if the logic makes sense. Confused.
But there are other differences that should give economists some pause. For example, the standard economic advice is that one should pay off high-interest debt before cheaper debt, of course. But many personal finance books advise prioritizing the smallest debts first as a self-help hack: Get those small wins, the gurus say, and you’ll begin to realize that getting out of debt is possible.
If you think this makes sense, it points to a blind spot in standard economic advice. People make mistakes: they are prone to temptation, they misunderstand risks and costs, and they cannot calculate complex investment rules. Good financial advice will take this into account, and ideally defend against the worst mistakes. (Behavioral economics has a lot to say about such mistakes, but it tends to focus on politics rather than self-help.)
There’s another thing that standard economic advice tends to miss: It aligns poorly with what veteran economists John Kay and Mervyn King have called “radical uncertainty” — uncertainty not just about what could happen, but Species of things that might happen.
For example, the standard economic advice is that we should ease consumption over our life cycle, accumulate debt while young, accumulate savings in prosperous middle age, and then spend that wealth in retirement. OK, but the “life cycle” idea lacks imagination about all the things that might happen in a lifetime. People die young, go through expensive divorces, quit well-paying jobs to pursue their passions, inherit tidy sums from wealthy aunts, win unexpected promotions or suffer chronic ill health.
It’s not that these are unimaginable results – I just imagined them – but that life is so uncertain that the idea of an optimal allocation of consumption over several decades is beginning to seem very strange. Well-worn financial advice to save 15 percent of your income, no matter what, may be ineffective but it has some power.
And there is a final omission from the standard economic view of the world: we may simply waste money on unimportant things. Many financial wise men, from the Ultra Frugal, Retire Early (FIRE) Financial Independence movement to my Financial Times colleague Claire Barrett (her book What they don’t teach you about money Hopefully soon we’ll overtake Kiyosaki), emphasize this very basic idea: We spend mindlessly when we should be spending consciously. But while the idea is important, there is no way to even express it in the language of economics.
My training as an economist has taught me a lot about value about money, giving me justified confidence in some areas and justifiable humility in others: I’m less likely to fall into get-rich-quick schemes, and less likely to believe I can outperform the stock market. However I also missed a lot. James Choe deserves credit for recognizing that we economists do not have a monopoly on financial wisdom.
Tim Harford’s new book is “How to make the world add“
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