Do you love math? Do you love doing research? Do you love calculating the probabilities of “X” happening if “Y” increases / decreases? I think it is fair to say the most people don’t. Hence, why we are always searching for rules of thumb or simple heuristics to allow us to make decisions and get on with life without taking up all our time. This tends to work well for small decisions we repeat every day. You go out to eat for lunch and choose a salad over a sandwich because the rule of thumb is salads are better for you. A few weeks later you are scanning through the menu again and, much to your surprise, any number of other choices would have been better due to the amount of “toppings” the salad comes with. You decide to make a new lunch choice and vow to be more careful. Lesson learned. Problem solved.
When financial rules of thumb don’t work
The breakdown happens when a rule of thumb attitude is used for complicated decisions which we only make a few times in our life. Einstein had a very insightful, and long, quote which we’ll paraphrase here as “Everything should be made as simple as possible, but not simpler”. As Financial Planners, that is one of the guiding principles for which we strive. We take all the math, research, and analysis that goes into retirement planning and attempt to explain it in the simplest way we can, without losing the original intent. For example, determining when to claim Social Security can be quite complicated. Our goal is to run all the varying scenarios and report which one is best for maximizing lifetime income, protecting against longevity, or supporting a surviving spouse, depending on which goal is most important to you. We can’t make it simpler because only you can choose what is most important for your family. If we used a rule of thumb, such as everyone is trying to maximize their lifetime income; then it could lead to an unfortunate result you may never get a chance to undo.
The list of decisions where financial rules of thumb can fail are endless. Never lease a car. Pay off your mortgage as soon as you can. Always delay social security until age 70. In a group setting when addressing dozens of people or in an article being consumed by millions, these are popular because they are right more often than they’re wrong. Plus, who doesn’t love a quick take away they can immediately use to improve their financial life.
If it were that easy there wouldn’t be 100,000 personal finance books with endless pools of varying advice. There would be one book. Only one book that you could look to for every decision. They could build a class around it in high school or college and you’d never make a bad financial decision ever again. Unfortunately, we looked, it just doesn’t exist.
Why personal finance fails when it isn’t personal
Clearly, we’re biased. After all, we provide personalized advice to clients. We feel that every financial decision should be moving you one step closer to your personal financial goals. If it isn’t personal, how do you know if it’s right?
A few days ago an article went out over several financial media channels (Marketwatch, Yahoo Finance, etc…) with this harmless enough title, “The new math of saving for retirement may boil down to this one, absurdly simple rule”. Subtitled with “Why you should be saving at least 10% of your salary”. If you assume this is an article employing you to save more, at least 10%, and demonstrating exactly why this is true you would be… right’ish?
The article starts with an odd attack on all financial advisers because they won’t just tell you what the magic number you need to save is. Apparently, it is because advisors think it is complicated and are afraid to give a number for fear of being legally responsible for the outcome. The author wants the “retirement industry” to provide “us”, with a magic number. A single, simple number to apply to everyone, everywhere.
The author then goes on to mention things that will impact people’s retirement saving like student loans, credit card debt, social security, longevity, & healthcare expenses (sounds like it is getting complicated). Luckily, the author saves the day using a model created by the EBRI, or Employee Benefit Research Institute. This model which can account for “contributions, market changes, Social Security benefits and salary growth, as well as a range of health outcomes and longevity prospects” will give us the answer. His conclusion, for millennials at least, is that the magic number is 10%.
Mass media financial advice is always lite on details
We’re not knocking the fact that LITERALLY EVERY FINANCIAL PLANNING SOFTWARE TOOL made today used by financial planners already does this. We are not criticizing the author for saying “Of course, everyone’s situation is and will be different, so 10% is a guideline, not a guarantee“ after HE JUST IMPLIED THIS RULE WORKS FOR EVERYONE. We will pretend for a minute it isn’t a big deal that he left out EVERY SINGLE MAJOR ASSUMPTION used in the calculation including investment rate of return, life expectancy, or how much income would that provide in retirement. No. Even if none of this is important to you, the result should be. The average 25-year-old making $30,000 a year today, saving 10% of their income, “cuts the risk of running out of money in retirement to about 30%, less than one chance in three.” ONE IN THREE! Who wants a one in three chance of ending up broke in retirement?
What if you are thirty instead of 25? The picture gets even worse. What if you live beyond the average age (whatever that is because he doesn’t list it) or are married and want to account for a joint life expectancy? Sorry, you get a coin flip for success. The reason company retirement plans are increasing the use of automatic enrollment and auto increases in contribution rates is because once employees decide, usually during their first week at work, they rarely revisit it. Imagining reading this article and thinking 10% really is your magic number. You set it and ten years later find out you are shooting for a target that you wouldn’t even consider a success.
What the financial media gets right
The upside of leaving out the details is it makes all this sound very easy. Save 10% and you’re good. That simplicity might just make someone who otherwise would have passed, thinking it was too complicated, get started for the first time. It could well change some people’s lives and it is hard to put a price on that.
In addition, the financial media has the opportunity to amplify a message more than advisers ever will. According to a 2019 CNBC survey, only about 17% of people seek financial advice from a professional. That leaves the majority of people looking for answers to these questions at the mercy of sites like Yahoo Finance. Whether or not we like it, they wield enormous influence and have the ability to do tremendous good, or significant harm.
How do you make personal finance personal?
Any advice that you receive from the internet, magazines or a friend, should be run through the filter of how am I different? Does the advice in question come from someone your own age and relative income level? If the decision would impact a spouse, are they married or single. Are you aware of anything that could be going on in their life or was this decision made within a vacuum? Maybe most crucial of all, what are they trying to accomplish and is that just as important to you as well. A recent consumer survey by lendedu highlights just how different our number one financial goal can be from person to person.
The closer you are to the person giving the advice, the greater the chances it might apply to you as well. You are not Warren Buffet, Kim Kardashian, or Andrew Luck so don’t take investing advice from them, or for them. Even better, start by making a list of the financial issues that mean the most to you. Maybe it includes being able to retire early and move closer to family or leaving a legacy for your grandchildren. Once you know what the end game is finding advice to match and avoiding advice which doesn’t, becomes simpler. We know it can still be complicated, but we’re here to help you make it as simple as possible, but not simpler.