Economist vs. Popular Financial Advice

Yale School of Management economist James Choi reviews some popular financial advice.

https://www.nber.org/papers/w30395?utm_source=npr_newsletter…

One surprise was that he tells his MBA students (who will all likely be high income earners) to go into debt “living it up” in their 20’s and 30’s and then quickly pay it off as their incomes invariably rise. Most personal finance books highlight early saving and the “power of compound interest”.

I confess that I spent a lot of money in bars and restaurants in my 20’s and 30’s, but I was saving a lot of money with my early attention to “the skim” of fees & commissions, and, of course using “rent vs. buy” to inform my housing decisions kept most of money in the stock market rather than a poorly appreciating Texas home.

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I would say there’s a difference between teaching economics and teaching financial management. Living it up as a young adult may stimulate the economy, but it teaches bad spending habits that can be difficult to break by the time you are expected to grow up, financially speaking.

Fuskie
Who would say you did it right by making sure you were taking care of your future self first before indulging in your current self at the time…


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CMF_Fuskie writes,

I would say there’s a difference between teaching economics and teaching financial management. Living it up as a young adult may stimulate the economy, but it teaches bad spending habits that can be difficult to break by the time you are expected to grow up, financially speaking.

I think bad habits and financial discipline are a separate issue. Life Cycle Finance (i.e., borrow to spend while you’re young, then pay it off as incomes grow will actually allow you to spend more money over your lifetime.)

https://www.bogleheads.org/wiki/Life-cycle_finance

As many point out, people with big IRA balances at age 80 may have wished they spent more when they were young, or retired a lot earlier.

Few people wish they spent more time in the office, as the “job creators” are learning with the post-COVID “return to the office” push.

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“One surprise was that he tells his MBA students (who will all likely be high income earners) to go into debt “living it up” in their 20’s and 30’s and then quickly pay it off as their incomes invariably rise. Most personal finance books highlight early saving and the “power of compound interest”.”

He is assuming the trajectory of rising income for a given group. Personally, it may not happen that way. Who knows what could? Savings cannot be optimal. It is just to have some cushion just in case so that you have an easier time just in case.

tj

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I don’t see how you separate the two.

Fuskie
Who thinks the most successful savers and investors for retirement are those who learned the value of money and the benefits of saving when they were teenagers…


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“One surprise was that he tells his MBA students (who will all likely be high income earners) to go into debt “living it up” in their 20’s and 30’s and then quickly pay it off as their incomes invariably rise. Most personal finance books highlight early saving and the “power of compound interest”.”

Yale MBA students are not the target audience of most simple, broadly targeted financial recommendations.

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Yale MBA students are not the target audience of most simple, broadly targeted financial recommendations.

True. But as Nobel Laureate Danial Kahneman points out, the simple-minded financial advice suffers from “narrow framing”, and rarely yields optimal results. A lot of people would benefit by using a little science and arithmetic in their planning.

https://discussion.fool.com/suboptimal-economic-thinking-3515946…

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Says Professor Kahneman, “People frame things narrowly in the sense that they save and borrow at the same time instead of somehow treating their whole portfolio as one thing.”

What’s an example of this?

If you’re investing at 10% long term, and borrowing at 5% (e.g. mortgage), is that “treating your whole portfolio as one thing”?

And if you’re saving at 0% and borrowing at 5% that’s not?

fdoubleol asks,

Says Professor Kahneman, “People frame things narrowly in the sense that they save and borrow at the same time instead of somehow treating their whole portfolio as one thing.”

What’s an example of this?

If you’re investing at 10% long term, and borrowing at 5% (e.g. mortgage), is that “treating your whole portfolio as one thing”?

And if you’re saving at 0% and borrowing at 5% that’s not?

When I bought my current home ten years ago, I paid cash for it rather than take out a mortgage. I happened to have enough money sitting in a money market fund at 2% and I could get a mortgage at about 3.3% at the time. It didn’t make sense to me to take out a mortgage if I had the cash.

Now some people might say you could mortgage the home and invest the cash in the stock market. But I already had a portfolio that was about 95% stock. Did I need to make it 97% stock with a home mortgage? Or does a mortgage-free home bought at a low-enough price to produce an S&P 500 like investment return add some diversification to the investment portfolio?

That’s what “treating the whole portfolio as one thing” looks like.

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But as Nobel Laureate Danial Kahneman points out, the simple-minded financial advice suffers from “narrow framing”, and rarely yields optimal results. A lot of people would benefit by using a little science and arithmetic in their planning.

Also true. Optimum results isn’t always the goal. Sometimes helping people avoid shooting themselves is a challenge.

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