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Why economics and personal finance don’t agree


Avoid incurring credit card debt. Start a fund for bad times. Start saving early for your golden years. And you should never, ever, ever forget how important compound interest is.

Most experts in personal finance agree on these kinds of basic rules. But a new working paper shows how popular books on personal finance and economic theory are often very different.

James J. Choi, a finance professor at Yale and the author of the paper, first looked at the top 50 personal finance books on Goodreads as of 2019. On that list are well-known books like “Rich Dad, Poor Dad” by Robert Kiyosaki, “You Need a Budget” by Jesse Mecham, and “I Will Teach You to Be Rich” by Ramit Sethi. There are also multiple books by top financial experts like Suze Orman and Dave Ramsey. Then, he compared what most people usually learn from personal finance books to the basic ideas and assumptions of mainstream economic theory.

The National Bureau of Economic Research posted the paper, but it has not yet been checked by other experts.

Choi finds that personal finance experts and economists have different ideas about how to save money, manage your investments, pay off debt, and buy a home. Personal finance experts may be wrong about some things, but Choi says that their advice is better than economic theory in two ways: it is easy for non-experts to understand, and it takes into account things like how hard it is to stick to a budget.

The psychology of managing money

Choi’s paper shows in the table below how personal financial advice and economic advice are different. Actively managed mutual funds are the only thing that both sides agree on for all of the five topics. Most people agree that the market is hard to beat. Instead, you should use index funds. 
Why does advice about personal finances often go against what economists say? The paper says that the first group tends to think about psychology, while the second group is more focused on logic.

For example, many personal finance experts want people to get into the habit of saving a certain amount of their income, even when they’re young and broke. This will make it easier for them to keep putting more and more money aside as their income grows. Economists, on the other hand, think it makes sense for people to save little or even go into debt at the beginning of their careers and then save a lot more when they start making more money.

In a similar way, Choi finds that nine personal finance books support what Dave Ramsey calls the “snowball method” for paying off credit card debt. In this method, people pay off their cards with the lowest balances first, no matter what their interest rates are. That goes against what economists know to be true, which is that it’s best to get rid of debts with the highest interest rates first. But he says that Ramsey and other people like him use the snowball method to help people stay motivated to get out of debt. This is based on the idea that people are more likely to stay on track if they have small wins along the way.

Personal finance books say that the best way to save money is to

The paper also has some interesting observations about the most common financial advice found in books. For example, the majority of the 25 books that gave specific advice on how big an emergency fund should be said that it should cover at least three months’ worth of living costs. 
Choi points out that economists and personal finance experts tend to have very different ideas about saving. They look at things like opportunity costs. For example, if you build up a big savings account, you might not be able to invest that money in the stock market or buy a new car to replace one that will cost you thousands of dollars to fix in the long run. Academics also know that people saving too much money can hurt the economy, which depends on people spending money on goods and services.

Experts in personal finance don’t have to worry about things like this. Their main focus is on their own lives.

How about reading?

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  • Ontario is changing its math curriculum to focus more on coding and managing money.
  • How making sustainable investments more personal can change the future of money


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