Why most personal finance is probably wrong
For some time now, I’ve had the feeling that a large proportion of the personal finance advice around – and some of it coming from established names in the industry – is wrong. Not the kind of ‘people just don’t get how this works’ wrong; more like the ‘world has changed and I’ve hardly noticed’ kind of wrong.
Okay, the basics probably still apply, I’ll give you that. In a nutshell, the basic principles of sound personal finance management are three:
- keep expenses down;
- drive income up; and
- use the positive difference to hedge for a/the future.
Personal finance writers place different emphasis on these three elements; they can also see the specifics differently. This doesn’t change the fact that, at a very general level, personal finance is simple and immobile: these principles are easy to understand at any time and in any situation.
Since the application of these three principles is very specific it can be very different depending on time and circumstances. I have mentioned before that my great-grandmother use to wear the family investments around her neck – made sense on the Balkans where you never knew when you’ll have to leave your home in a hurry. So all wealth was in different sized gold coins and these were worn be the senior woman of the family.
Obviously, I don’t wear our investments around my neck; some, John would argue, are in our house, others in our pension pots and the most recent ones are steadily making a bit of interest in Nutmeg and the House Crowd.
I believe that at the moment most personal finance advice that is sufficiently specific to be practically useful is wrong because the world, the economy and our lives have changed.
You want examples? How about the famous adage ‘pay yourself first’? This makes sense only when you get regular monthly income and wish to ensure that you put some of it aside. It is also pretty useful when the set amount you put aside is what you can really afford. Some authors, like Robert Kiyosaki in Rich Dad Poor Dad, take this to extreme; this is presented to mean that you ought to pay yourself first even if it means that you get behind with some bills.
Neglecting to pay your bills on time may have been something one could get away with in an age when databases were not connected. Today, delaying payment can, and indeed eventually will, affect your credit score. Even if you don’t want to borrow ever again – which will be a mistake since cheap borrowing can be a great leverage for building wealth – having a good credit score is not a bad idea.
Or this old herring about investing in real estate. Most sages of personal finance from the last decade advised us to buy real estate. Which probably was a good idea at the time but this bubble seems to have burst as well. At the moment the return on investment in real estate is fairly low, the outlay of capital rather large and the headache it presents like the worst handover ever.
And let’s not forget that Joe Dominguez, otherwise a man of considerable understanding and foresight who got many things in personal finance right, preached that the safest investment for our retirement is to buy bonds. Safe bonds may be, but at the moment they return very little and anyone who buys bonds for retirement may be better off keeping their money under the mattress.
These examples illustrate that specific personal finance advice can get dated and even become obsolete. But let me tell you about some of the changes that you should look for.
From ‘jobs’ to ‘work’
If this sounds familiar this is probably because I have mentioned this one before: repeating yourself only means that something is very important. And this one is.
Most of us focus on jobs most of the time and structure our lives accordingly. Even when we dream about ‘getting out of the rat race’ and ‘being our own boss’ we still think about employment – we only put ‘self’ in front of it. This is problematic, however, because having a job, being employed, is about a contract between you and an employer (this can be a contract between you and yourself); your job is what is in your job description.
Work, on the other hand, is a true measure of the value we contribute. Focusing on work, instead of jobs, has important implications one of which is that you don’t have to have a job to contribute value. Another one is that one should always be on the lookout for the next bit of work, for the next way to contribute value.
This also has implications for the way in which we run out finances; in fact, truisms like ‘pay yourself first’ stop making sense and give way to mantras like ‘keep your dam full so you life can be nourished in times of drought’.
From ‘pension’ to ‘income’
Most of us habitually focus on building a ‘pension’. Guess what? You actually don’t need a pension, you need income. Focusing on pension makes you focus on a specific instrument; further, this instrument made sense when it went through (and generally included) employer contributions of some kind.
If there is no employer you have a choice to either start a private pension fund or build income. It is your call but given our latest experience with private pension funds I’ll go with building income any time.
Start a pension early
Again, in a time when pensions were the usual source of income in our dotage this advice made sense.
In light of my previous point this is likely not to be the case. In fact, investing in oneself to develop the skills and competencies one needs to build sustainable, healthy income streams is probably a much better idea. It may turn out that compound interest is somewhat overrated.
Buy a house as early as possible
According to a study by TD Direct Investing a sizeable proportion of young people (over half) in the UK still believe that they ought to buy a house because it is their main investment. Debates regarding whether the house you live in is an investment and an asset or not aside, this is misguided.
Remember my point about the world moving away from ‘jobs’ to ‘work’? Well, today few will dispute that jobs are going and likely not coming back. This means a volatility of income and shift of priorities: from buying a house with a mortgage to building a large reserve and eventually later – much later – buying a house without, or with very little, mortgage.
Assuming you have a job and you are in your 20s it is likely you will move around chasing jobs and positions. Every time you sell and buy a house, and move, this costs you (in the UK at least) between £40,000 ($64,000) and $50,000 ($80,000). You lose money even in a buoyant market.
Do you still think is a good idea to buy a house as soon as possible?
Much of the financial advice around is rather outdated and hence wrong. The world has changed and it is time that personal finance moves with it.