Ten Nearly Universal Truisms of Personal Finance
We all make money mistakes as the deck is stacked against us
I’ve engaged with lots of people about their personal finances — young and old, optimists and pessimists, richer and poorer, risk-takers and avoiders, artists and engineers, spenders and savers, over- and under-educated, etc. Hopefully, they’ve learned as much from me as I have from them.
From this admittedly biased sample (that is, they were willing to interact with me), I’ve deduced a set of nearly universal truisms about how we manage our personal finances that cause us to make flawed decisions about saving and spending our money. Maybe you can learn something from this list.
1. No one is looking out for you.
When it comes to your personal finances, it’s you against the machine. You need to determine how much to save, where to invest, which mortgage best serves your needs, and why some complicated life insurance pitch is not in your interest. Good luck.
2. The financial services industry is extractive.
Paul Volker once joked that the only useful innovation in the banking industry in 20 years was the ATM. Matt Taibbi’s famously described Goldman Sachs as “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” As metaphor goes, that’s priceless.
Admittedly less colorful but I see the financial services industry as a gravity machine that imperceptibly but continuously extracts fees from consumers’ pockets into its black hole of profits, bonuses, artwork, and bespoke suits.
3. We undervalue the future.
Our brains are just not wired for long term financial planning and thus, we over-consume in the present and under-save for the future. This short-term bias is hard to overcome but if you don’t, you’ll be full of regret when nearing retirement age and realizing you’ll have to reduce your spending, work longer, or both.
4. We don’t understand compound interest.
We underestimate the power of compound growth over long periods.
Inflation is illustrative. At a seemingly modest rate of 4%, inflation halves one’s purchasing power after just 18 years. That’s a big hit over less than the span of a full retirement for most people.
This is the danger of credit card debt. At an interest rate of 25%, a credit card balance nearly doubles every three years.
The power of exponential growth is hard to grasp but make it your friend (as a saver) rather than your foe (as a borrower).
5. Risk is subtle.
We all want the safety of bank CDs coupled with the high returns of the stock market. You can have either but not both and most people understandably have a hard time deciding where on the continuum they want to be.
And, we over-insure affordable risks and under-insure catastrophic ones. People purchase extended warranties for phones and appliances and opt for small deductibles for auto and home insurance.
On the other hand, people often have insufficient life insurance for their present circumstances and too little liability coverage for a catastrophic claim.
We over-insure when the likelihood of a claim is high but its cost is small and under-insure when the likelihood of a claim is low but the cost could be catastrophic. We should do the opposite.
6. Life is a mix of luck and skill.
We fool ourselves in believing skill explains our lucky breaks in life but negative outcomes are due to bad luck. As Molly Ivins said of George W. Bush, “He was born on third base and thought he hit a triple.”
We learn the exact wrong lessons from these experiences. Poker players are prone to this attribution error as only the best ones are self-critical and reflective enough to learn from their mistakes. Instead, mediocre players presume wins are due to skill and losses are due to bad luck. I fall into that mindset and that’s one of many reasons why I’m not a world-class poker player.
7. Things that sound too good to be true, always are.
This one doesn’t need much explanation.
8. It’s hard to get off the hedonic treadmill.
If your expenses always grow proportionally with your income, you’ll find yourself on a hedonic treadmill that’s hard to dismount. You'll have more stuff but you won't be happier.
Springsteen has a song lyric for almost any life situation and here’s his version:
Poor man wants to be rich
Rich man wants to be king
And a king ain't satisfied
Until he rules everything.
Stay off the treadmill.
9. Keeping up with the Joneses is costly.
To a certain extent, we’re less concerned with how much money we have than how we compare to our friends, neighbors, co-workers, or families. This can have an insidious effect on us.
Similarly, many of us feel social spending pressure. I see this often:
students who want to maintain a strong social network where it seems like everyone else has an unlimited entertainment budget
wedding invitations in which it’s unaffordable to fully participate
social engagements that are uncomfortably expensive
pressure to send your kid to a college that is unaffordable
These challenges are difficult but if you don’t wrestle them to the ground, they’ll bury you eventually.
10. Money is an emotional topic.
It causes anxiety, it’s taboo to talk about, and somehow it also bores us. No wonder few of us feel capable with our personal finances and we find it hard to be rational, cool-headed, or cold-blooded about our financial decision-making.
If these feelings ring true, trust me when I tell you that you have a lot of company.