Sometimes the emotionally satisfying advice isn’t as financially sound.
- Academic economists have different opinions than personal finance gurus when it comes to Americans and their finances.
- It’s common to hear that your savings rate should be steady over your lifetime, you should avoid adjustable-rate mortgages, and you should use the snowball method to pay off debt.
- Ultimately, it’s best to choose the money management techniques you’ll stick with, versus those that are “correct.”
We cover a lot of advice from personal finance gurus here at The Ascent. In many cases, these people are plugged into the spending and savings habits of Americans, and sometimes, they themselves have been way down in the depths of debt and dire financial circumstances, so they have wisdom to impart. Plus, advice from best-selling authors and radio show hosts tends to be a lot more accessible than information from academics, like economists. That said… are personal finance gurus always giving you the right information?
Recently, the podcast Freakonomics Radio (a personal favorite of yours truly) asked the question, “Are Personal Finance Gurus Giving You Bad Advice?” In this episode, the Freakonomics team spoke to Yale University economist James Choi, who conducted a survey of advice given in 50 books by personal finance experts versus wisdom espoused by economists, and noted the differences when it came to saving money, managing debt, getting a mortgage, and more. Let’s take a look at some of the loudest opinions in the world of personal finance and see how they stack up to advice from economists.
1. Your savings rate should be steady!
It’s a common refrain among personal finance experts: aim to save a certain percentage of your income, no matter what age you are, what job you have, or what stage of life you’re in. According to Choi’s findings from researching economic theory, it’s off base when you consider things like income versus spending over one’s lifetime. When you’re younger, you likely won’t make as much money as you will in middle age, and so it might be hard, or downright impossible to manage your bills and expenses while also saving that certain percentage of your income. Meanwhile, you might also have some pretty big expenses as a younger person. Maybe you want to get married and have a big wedding in your 20s or 30s. Maybe you want to buy a house, which comes with a high upfront cost.
As you get older, you’ll already have done these big expensive things, and you’ll also likely be making more money at work. This frees up more of your income to save. That said, if you get in the habit of saving money at an early age, it will certainly be easier to keep at it as you get older (and make more money). Plus, you can take advantage of the miracle that is compound interest.
2. Don’t get an adjustable-rate mortgage!
Many personal finance gurus advise against adjustable-rate mortgages (ARMs). From an emotional standpoint, this makes sense. After all, when you get a fixed-rate mortgage, you won’t have to worry about your mortgage payment changing over the life of the loan. And if inflation is up and rising, like it is right now, this can be a good thing. But ARMs usually come with a lower interest rate to start with, and you’ll keep that for a period of time. For example, if you get a 5/1 ARM, you’ll have that low starting interest rate for the first five years before it starts changing every year. And what if inflation is moderate over the course of your loan? You could be losing money with a fixed-rate mortgage, unless you’re already maxing out your budget to buy a home (which isn’t the best idea).
So consider getting an ARM, and if you don’t want to take the chance of your payment increasing after that first period of fixed interest, refinance to a fixed-rate loan before it’s over. Right now, getting into a home by using an ARM should save you money, as the average rate for a fixed-rate mortgage is 7.08% as of this writing, while the average rate for a 5/1 ARM is 5.96%.
3. Snowball your debt payoff!
Per Choi’s research, about half of the personal finance writers whose books he read espoused the snowball method for paying off credit cards and other high-interest debt, while half advocated the more mathematically effective strategy, the debt avalanche. Economists like the debt avalanche method too, because you will spend less money paying off your debt by focusing on the debts that have a higher interest rate first.
However, paying off the smallest amount first and working your way up gives you some early wins, which can compel you to keep going, and keep paying things off. I recently got out of debt using the snowball method, and it was indeed very mentally and emotionally satisfying, despite likely costing me more money overall due to me not prioritizing higher-interest debt payoff first.
Does any of this matter?
So, knowing that some of the most cherished opinions of personal finance experts are off-base from an economic standpoint, does any of it really matter? Perhaps not. And Choi acknowledges this, based on the availability of advice from personal finance gurus versus from academic economists and the fact that many people find it easier to follow a simple directive like, “save 20% of your income no matter what,” or “avoid adjustable-rate mortgages.”
Ultimately, we’ve all got to manage our own money, and try to do our best to cut through the noise and find the ways that work for us and that we’ll stick with. The odds are good that you’ll find success with some method promoted by a popular personal finance guru, by way of their website, book, or podcast. And that’s perfectly okay.
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