3 things personal finance “experts” get wrong

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Sometimes emotionally satisfying counseling isn’t as financially sound.

Key points

  • 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 stable throughout your life, that you should avoid variable rate mortgages, and that you should use the snowball method to pay off your debts.
  • At the end of the day, it’s better to choose which money management techniques you stick with, over which ones are “correct”.

We cover plenty of advice from personal finance gurus here at The Ascent. In many cases, these people are plugged into the spending and saving habits of Americans, and sometimes they themselves have been deeply in debt and in dire financial straits, so they have wisdom to impart. Also, advice from best-selling authors and radio show hosts tends to be much more accessible than information from academics, such as economists. That said… are the personal finance gurus always giving you the right information?

Recently, the podcast Radio Freakonomics (a favorite of yours) asked the question, “Are personal finance gurus giving you bad advice?” In this episode, the Freakonomics team spoke with Yale University economist James Choi, who conducted a survey of the advice given in 50 books by personal finance experts in relation to the wisdom adopted 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 strongest opinions in the world of personal finance and see how they stack up against the advice of economists.

1. Your savings rate must be stable!

It’s a common refrain among personal finance experts: try to save a certain percentage of your income, regardless of your age, job, or life stage. According to Choi’s findings from economic theory research, this is irrelevant when you consider things like income versus expenditure over a lifetime. When you’re younger, you probably won’t make as much money as you did in middle age, so it may be difficult, if not impossible, to manage your bills and expenses while saving that certain percentage of your income. During this time, you might also have some pretty big expenses as a youngster. Maybe you want to get married and have a big wedding in your 20s or 30s. Maybe you want to buy a house, which has a high initial cost.

As you get older, you’ll already have done those big, expensive things, and you’ll probably be making more money at work. This frees up more of your income to save. That said, if you get into the habit of saving money at a young age, it will definitely be easier for you to stick to it as you get older (and earn 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, that 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 on the rise, as it is now, that may be a good thing. But ARMs usually come with a lower interest rate upfront, and you’ll keep it for a while. 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. What if inflation is moderate over the life of your loan? You could lose money with a fixed rate mortgage unless you’re already maxing out your budget to buy a house (which isn’t the best idea).

So consider getting an ARM, and if you don’t want to risk your payment going up after that first fixed interest period, refinance to a fixed rate loan before it’s over. Right now, getting into a home using an ARM should save you money, as the average fixed rate mortgage rate is 7.08% at the time of this writing, while that the average rate of a 5/1 ARM is 5.96%.

3. Snowball to pay off your debt!

According to Choi’s research, about half of the personal finance authors whose books he read adopted the snowball method of paying off credit cards and other high-interest debt, while half advocated the the most mathematically efficient strategy, the avalanche of debt. Economists also like the debt avalanche method because you’ll spend less money paying off your debt by focusing on debts that have a higher interest rate first.

However, paying the smaller amount first and progressing gives you quick wins, which may require you to keep going and keep paying. I recently got out of debt using the snowball method, and it was indeed very mentally and emotionally satisfying, although it probably cost me more money overall because I didn’t prioritize pay off the higher interest debt first.

Does any of this matter?

So knowing that some of the most popular opinions of personal finance experts are irrelevant from an economic point of view, does it really matter? Maybe not. And Choi acknowledges this, based on the availability of advice from personal finance gurus over academic economists and the fact that many people find it easier to follow a simple guideline like “save 20% of your income no matter what. happens” or “avoid adjustable rate mortgages.”

At the end of the day, we all have 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 will stick with. Chances are you’ll succeed with a method promoted by a popular personal finance guru, through their website, book, or podcast. And that’s perfectly fine.

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