Are Personal Finance Gurus Giving You Bad Advice? (Update)

Hey there, it's Steven Dubner. Happy New Year. If you were the kind of person who makes

a New Year's resolution, there is a good chance that resolution has to do with your personal

finances. This has always struck me as a bit odd since there is no shortage of people

out there who give financial advice, so maybe that advice just isn't working. That is

the question we set out to explore in 2022 in an episode called Our Personal Finance

Guru's Giving You Bad Advice. We thought it might be a good idea to play it again now.

We have updated facts and figures as necessary. I hope it helps. As always, thanks for listening.

I've got a question for you today, a personal question. It's about something you may not

be so comfortable talking about. Let me give a little background first. Years ago, I was

writing a book about the psychology of money. I was going to call it money makes me happy except

when it doesn't. But I ended up putting that book in a drawer when I met Steve Levitt, an

economist at the University of Chicago, and instead, we wrote Freakonomics. And that's turned

out pretty well, but the money curiosity never left me. I've always been intrigued by how

we think about money, or maybe more accurately, how we fail to think about money. It is one

of those topics like sex and religion and politics that's often driven less by thoughtful

consideration and more by emotion. Money is so versatile, so central to our daily decision-making

that we attach all sorts of emotions to it. Excitement, fear, lust, regret.

It's hard to name an emotion that doesn't get attached to money. And this can make money hard

to talk about, in some cases, even taboo. Today, I'd like to put aside that taboo and start with

a simple question. Where do you get advice about money? Here's how some of our other listeners

answered that question. That usually get it from YouTube. There's a channel called The Financial

Diet that I really enjoy. Mainly through financial podcasts, so like the money guys show,

afford anything. Ray dollios how the economic machine works. It's a YouTube episode on his channel.

I actually started a group with my female friends and colleagues. We call ourselves Per Strings,

it's kind of a joke. And we meet everyone to three months to just talk about financial topics,

share our strategies. When you're younger, you get it from parents and friends. As I get older,

rely more on financial websites. Honestly, I get all my personal finance advice from my dad

because he is almost never wrong with this kind of thing. You'll notice that none of those

listeners explicitly said they get their money advice from a CFP, a certified financial planner.

Perhaps this isn't surprising. There are roughly 100,000 CFPs in the US versus 131 million households.

So even though financial advice seems like something you should be willing to pay for, most people

aren't. But there's another place where no listeners told us they get money advice. From economists,

why is that? Economists must have a lot of advice about managing your money, right?

Heck, and I'm theory doesn't really have a lot to say about that right now,

which is kind of a shock and a scandal, I think. There is at least one economist who does have a lot

to say. And he would like you and me to listen to people like him rather than turn to the podcasts

and YouTube channels and books written by popular money advisors. There are some pretty significant

differences between what economists would recommend versus what these popular authors would recommend.

Today on Freakinomics Radio, a smackdown between the economists and the popular finance experts

with your money in the middle. How many people has Dave Ramsey helped out of debt versus the average

academic economist? It's a million to one. Also, we'll hear your biggest money mistakes. All that

starting right now.

This is Freakinomics Radio, the podcast that explores the hidden side of everything

with your host, Stephen Dubner.

I'd like you to meet James Choi, I'm professor of finance at the Yale School of Management.

Choi has a PhD in economics and economists have a lot to say about money when it comes to macro

stuff, fiscal policy, monetary policy, corporate finance, investment strategies, things like that.

But when it comes to micro stuff, questions about money that your eye might have,

what's called personal finance or household finance, most economists have little to say.

Why is that? I asked James Choi if the kind of person with the brain power to do big macro thinking

may just consider household finance day class A. I don't think it's day class A, but I think

it's a complicated problem that may end up giving you a messy solution, which is never quite

intellectually satisfying. There is this intellectual infrastructure in, say, macro economics.

So we're going to study business cycles, we're going to study inflation, we're going to study

unemployment. And so there are conferences, there are grants, there are journal articles.

There's this momentum that's created by the intellectual infrastructure that causes scholars

to produce papers in that area. Now this field of household finance, it's been around for a while,

but it was only really named as a field in the last 15 or so years, maybe in the next 10 years

that there will be a lot more smart people that start thinking very seriously about this sort of

question. Choi recalls hearing another theory from an elder statesman in his profession about why

most economists don't care about household finance. He hypothesized that there was

kind of this division of labor in the early 20th century when business schools are being set up

where business schools were for men and they were going to go to corporations and they were

going to manage corporate finances and they were going to do asset management. And so the fields

of corporate finance and asset pricing, these were serious fields that were worthy of study in

business schools. And the household finances, the personal finances, that was women's work.

Choi himself got interested in personal finance because he is also interested in behavioral

finance. When you actually look at what people are doing with their financial lives, you realize,

hey, they're doing some weird stuff and you can't help but go in a behavioral direction.

So he set out to design a personal finance course to teach at Yale. And I was looking for a

textbook. It seemed natural to look at some of these popular books that were out there because

there's so many of them to see what do they have to say. And maybe they have some very practical

on the ground advice. And I looked at a few of these books and I thought, wow, some of this advice

is either stuff that I disagree with or stuff that I think is flat out wrong. But I had to teach

the course this semester of starting. And so I settled in a book and I kind of went on my way

was the book you settled on popular finance for dummies. It's actually a surprisingly good book

despite the title. The title is actually personal finance for dummies by Eric Tyson. But let's not

read too much into the fact that the one popular finance book that an economist dain't to teach,

he gets the title wrong. Anyway, so that plan to the seed of this idea that maybe it would be

interesting to do a more systematic survey of what these popular authors were writing for this

systematic survey choice selected the top 50 personal finance books as measured in 2019 by the

book site Goodreads. And so that started this multi-year project where I had a team of

undergraduate RAs read these 50 books and create their own taxonomy. And then as I was trying to

pull all that together, I just ended up feeling that I needed to read these 50 books myself

and do some close textual analysis of the relevant passages. And that's kind of where the paper

ended up at the end of that entire process. The paper choice referring to is something he

published in 2022. It's called popular personal financial advice versus the professors. In it,

he examines the advice given in books like Rich Dad Poor Dad by Robert Kiyosaki, The Millionaire

Next Door by Thomas Stanley and William Denko, and Women in Money by Susie Orman. These are books

that sell millions and millions of copies. Now, some popular finance books are written by certified

financial planners, or at least they distill the best practices that CFP's offer. But many are not.

Many popular finance authors also host podcasts or TV and radio shows Dave Ramsey, for instance,

has a radio show that is said to reach millions of listeners each week. A good research paper

by an economist, meanwhile, might get a few hundred downloads, maybe a few thousand if they're lucky.

Let's face it, the money book for the young fabulous and broke by Susie Orman might sound

a wee bit more accessible than an econ paper like optimal life cycle asset allocation,

understanding the empirical evidence from the economist really are looking at arcane

journal articles full of equations and math. There is, as far as I know, no or very few

books that are written by academic economists that are really trying to speak to the common person.

But what if the economists have better financial advice than the authors of these books?

Wouldn't that be worth knowing? Choi set out to compare the advice from these books to similar

advice from the economics literature. He focused on a set of typical issues like home mortgages,

debt repayment, spending versus saving, investment style, things like that. And he found what he calls

some pretty significant differences between the economist's recommendations and the advice in the

books. Now, often, these differences come about because the authors are trying to make concessions

to human frailty. So either failures of willpower, a motivation, or there's this interesting notion,

especially in the savings domain, about building a discipline where if you habitually save even when

you're young and you're relatively low income, that's going to make you into the type of person

that is able to save and live frugally in your middle age and your older years as well. And that's

something that's completely absent from economic models. This kind of Aristotelian notion of building

virtue by the things that you do. But it seems that economists offer the opposite advice that you

want to smooth your consumption over time, not your savings. That's right. So you should save

relatively little when you're in your 20s, then when you're in your late 30s and 40s, you should

become a super saver. Flip that switch and be saving large percentages of your income. And the

reason that's better is why it's actually a very simple conception of human joy and sorrow,

which is that the fourth piece of pizza that you eat is less pleasurable than the third piece of

pizza you eat. And the fifth piece of pizza you eat is less pleasurable than the fourth piece of

pizza you eat. And so that leads to the very common recommendation from economic theory that you

should have a pretty consistent level of expenditure from year to year. Because it just doesn't make

sense to have 10 slices of pizza tomorrow and no slice of pizza today. The technical term for that

is consumption smoothing. Now, I think in reality, the relationship between how much we spend on

ourselves and how much joy we get changes over time, maybe next year you're getting married.

And it will bring you a lot of joy to have a blowout wedding. And so you spend 10, 20,

$30,000 more than you otherwise would have. And that's not at all a mistake. That's something

that you should do. Or you know, you're single, you're young, you just graduate from college,

you're living in Manhattan. What a glorious thing that is. And so maybe it is optimal for you to spend

more than you otherwise would in those years. And then you know that in five years, so you're going

to move back to the low cost of living midwestern town that your family's in. And so it just doesn't

make sense to have a consistent level of spending across those years. But generally, Choi says,

economic theory would suggest we smooth our spending across our life cycle. Most popular finance

books, meanwhile, recommend the opposite that instead of smoothing spending, you should smooth,

you're saving. In other words, you should put aside the same percentage of your income every year,

no matter how much or how little you make. One popular book in Choi's analysis is called

the index card, why personal finance doesn't have to be complicated. It was written by Helene Olin,

a journalist, and Harold Pollock, who is a professor at the University of Chicago, but not in

finance or economics, he works in public health policy. Pollock and Olin argue there are just

10 simple rules to know about money, all of which can fit on a single index card. Rule number one,

for instance, strive to save 10 to 20% of your income. Back in 2017, we interviewed Pollock for

an episode called everything you always wanted to know about money, but were afraid to ask. And we

did ask him about that simple savings rule. I got a bunch of emails that were essentially

the following form, you know, Dear Professor Pollock, I'm a 28 year old single mom and I work as a

cashier. You have just told me to save 20% of my money for you. And my response is to all of those

emails was, you know what, you're totally right, I totally see where you're coming from. I think

that my original card was really good for middle-class people like me. It wasn't quite as good for

people that were at different stages in their life. Here's another big topic where economists and

popular book authors disagree. What type of mortgage to get if you buy a house? The book authors

prefer what are called fixed rate mortgages. You are locked into an interest rate for the duration

of the loan, which is often 30 years. Economists, unless interest rates happen to be very low,

they prefer adjustable rate mortgages, which means your interest rate can move up or down depending

on market conditions. I asked James Choi to explain why economists prefer the adjustable rate.

In his paper, the explanation was fairly complicated. It is complicated. The reason that

popular authors strongly recommend fixed rate mortgages is that they sound very safe. You have

a fixed monthly payment. What could be safer than that? Now the hidden risk in fixed rate mortgages

lies with the inflation rate. So you take out the mortgage. Inflation comes in unexpectedly high

over the life-fear mortgage. That means that the real burden of your debt repayments is lower than

was expected, but there's the flip side, which is if inflation is surprisingly moderate

over the course of your mortgage, then your real payment burden is higher than otherwise would

have been. There is a risk that is associated with fixed rate mortgages that just happens to get

realized slowly over the life of the mortgage. What about an adjustable rate mortgage?

Adjustable rate mortgages, they feel quite risky because their monthly payment moves around

over time. That's why the popular authors are quite negative about the adjustable rate mortgages,

and if they do recommend the adjustable rate mortgages, they typically have an upfront period

where the interest rate is fixed for three years or five years or whatever. They say make sure

that this fixed rate period is coinciding with the length of time that you're going to stay in

the house and basically don't expose yourself to the floating rate portion. But actually,

adjustable rate mortgages are relatively low risk on another dimension, which is that their

real payment burden over the long run is almost completely insensitive to the inflation rate.

So the real payment burden of adjustable rate mortgages in some sense is less

volatile than for fixed rate mortgages. Now, there's another factor, which is that adjustable rate

mortgages tend to, on average, have lower interest rates than fixed rate mortgages.

So you kind of put all those factors together and at least the two economic models that have

really been out there in the literature suggests that for most people, the adjustable rate mortgage

is preferable unless the fixed rate mortgage rate is kind of a historic low. Or if you're really

stretching your budget to buy your home, in that case, you probably should go with a fixed rate mortgage.

Okay, I think we are starting to get a sense of why most people don't go to economists for

financial advice. I did ask Choi whether most economists he knows choose an adjustable rate mortgage

as his research advises. I have an ask, but I'm going to guess that most of them have fixed rate

mortgages. Uh-oh. So wait a minute. You're saying economic theory says that adjustable is plainly

better. Why would economists themselves not follow that advice? Many economists actually don't put

a lot of expert thought into their own personal finances. That's one. And two, the academic literature

on optimal mortgage choice, I think is not very well known when I started teaching this personal

finance course a few years ago. Many of my economist colleagues told me, you know, I should take that

course. And then a little hobby of mine is to just ask economists colleagues, hey, you made

this financial decision. How did you make it? And it's usually some very ad hoc process or they just

went with the default option in the retirement savings plan. There is often not a high level of

sophistication in the way these folks are managing their personal finances. And I think that

it has to do partly with the professional incentives in our field where we are rewarded for

writing down, say, highly abstract models and solving them. And so when it comes to their own

personal finances, they end up falling back on rules of thumb and ad hoc procedures.

So most economists, James Choi says, prioritize high level research over low hanging household

finance questions, which, let's be honest, makes a lot of sense. That's where their professional

incentives are pointing them. And if that means not thinking much about their own finances,

so be it. Still, it does make me wonder why we want to look to economists for financial advice

at all. And there's another issue. Even if economists are really smart and good at math,

do they really get what it means to think like a human? After the break, one popular book author

says he doesn't think so. You cannot read a paper or look at a spreadsheet and change the

amount of dopamine in your brain. My name is Stephen Dubner. This is Freakonomics Radio. We'll be right back.

Before the break, the Yale Finance Professor James Choi was telling us that most people preferred

to get their personal finance advice not from economists like him, but from the authors of popular

books like Morgan Housel. I am the author of the book The Psychology of Money and I'm a partner

at the Collaborative Fund. The Collaborative Fund is an investing firm, but Housel isn't on the

investment side. He is essentially the house author writing and speaking about finance. Before that,

he wrote for the Motley Fool and the Wall Street Journal. He published The Psychology of Money

in 2020, too late as it turns out to be included in the top 50 personal finance books that James Choi

analyzed. Otherwise, it would have been included. Housel's book has sold more than two million copies.

We've spent the last two years struggling to keep it in stock. We just can't print enough.

Since we spoke with Housel, he's published another book called The Art of Spending Money. It, too,

was a best seller. He grew up in California and he was a competitive ski racer.

The quirk, I would say, is that I was a ski racer during my high school years, during the years

in which other people would go to high school. I did not attend a high school. I did an independent

study program that was sanctioned by the state of California, but I did virtually nothing to get a

quote unquote diploma that they gave me when I was 16. When he was 17, two of his close skiing friends

died in an avalanche. Yeah, and known them forever. We'd ski together, you know, six days a week for our

entire adolescence and teen years. And I would been with them that morning. We were doing this adabounds

skiing, which is illegal. We would ski down this adabounds run and then we would hitchhike back

because when it's adabounds, there's no chairlift. They went and did this run again. I decided to skip

it and I was going to go pick them up in my car rather than them hitchhiking home. And that was when

they were killed in an avalanche. Their bodies were found the next day. And then a few months after

that, I broke my back skiing. So that was kind of the wake-up call of like, okay, it's time to go figure

out something else to do with my life now. He worked some odd jobs, did some community college,

and then some university. I eventually transferred into the University of Southern California,

which is where I got my degree. And you studied economics, right? Yes. Looking back, do you feel that

you learned anything particularly useful, interesting, about personal finance by studying economics

in college? No, I really think the answer is no. I've thought really deeply about this. And it's

not to say that I didn't learn anything useful. I mean, the most useful thing I got is I met my wife

at USC that was far and away worth the cost of admission 10 times over. But in terms of what I learned,

when you learn economics at the academic level, you are very familiar with this. It is taught as a

math-based subject where two plus two equals four and there is one right answer. In the real world,

though, it's not like that at all. It's a much mushy or topic. You know, people do not make

financial decisions on the spreadsheet or on the chalkboard. They make them at the dinner table.

And the gap between those two things can be 10 miles wide. So it's not that I didn't learn

anything useful about economics in college. It's just that I was completely blind to the difference

in how emotions and psychology and sociology, keeping up with the Joneses, how all those topics

play into financial decisions that tends to be ignored at the academic level.

I think this is a really important point that Housel is making here. That psychology, especially,

plays a big role in our money decisions for better or worse. And that economists typically

haven't had much interest in or even awareness of basic psychology. Many of their models assume

the sort of rational statistical decision making that not many human beings actually practice.

But there has been a small revolution in this realm, behavioral economics, it's called,

which is a blend of econ and psychology. We have done many episodes on this show about

behavioral economics. And James Choi calls himself a behavioral economist. So I asked Morgan Housel what

he thought of Choi's new paper, which attacks a lot of the advice given by writers like Housel.

My general response to the paper was it's based off of this idea that economists can have the

quote-unquote right answer to these problems, that they know the right thing to do with their

money. And then they can therefore compare right versus what's actually out there. And that is an

idea that I fundamentally disagree with. There's not the equivalent of 2 plus 2 equals 4 in personal

finance. You cannot read a paper or look at a spreadsheet and change the amount of dopamine

and cortisol in your brain. You can't do it. I think the best that we can do as individuals

is look at our own personal financial past and realize that that is probably how we're going to

roughly behave in the future. If you are the kind of person who panicked out of your stocks in 2008

or March of 2020, you are probably going to do it the next time. A lot of the evidence shows that

we will not learn from these mistakes because it's easy to underestimate how quickly the emotions

will come rushing back during the next surprise, during the next crisis. These are not things I have

to do with a lack of intelligence or lack of information. It's just how we're wired.

Let me disagree here with Morgan Housel and take the side of economists. Or at least

the side of science. Even if it's true that we are wired, as Housel says, to have certain

emotional responses to certain stimuli, the science suggests that much of our early wiring is

obsolete in the modern world. But it may be that our emotional responses to money aren't wired.

It may be that we've been conditioned into certain responses. Or maybe we're just responding to

incentives and there are a lot of incentives to respond to. Think about the size of the financial

services industry and the whole consumer economy. There are thousands of firms doing everything

they possibly can to get us to spend money in ways that may not be in our best interest.

Who really thinks it's a good idea to pay 15% interest on a credit card other than the credit

card company? It's also true that a lot of us fall into bad habits when it comes to money.

And as we know, habits are sticky. But that doesn't mean we have to just give up.

Rather than curse the fact that we may be wired to behave a certain way, we try to break our bad

habits. Yes, it can be hard, but also worthwhile. Think about smoking. Once the evidence was clear

on the danger of smoking, we collectively put a lot of resources into curtailing this bad habit.

And that effort has been fairly successful. So shouldn't we at least try to change our bad

financial habits? Maybe we do this from the demand side that's us, the consumers, or from the

supply side that's the companies that are selling to us, or maybe both. Let's take a look at consumer

debt. One of the biggest disagreements between the economists and the personal finance authors

is how to pay off credit cards and other consumer debt. Here's how James Choi summarizes the debate.

Economists would say that the no-brainer thing to do is to focus your payment on the highest

interest rate debt that you have, because that's what's costing you the most to sustain.

And about half of the popular authors say you should focus on the debt that has the highest

interest rate. But then I'm seeing what you write about Dave Ramsey in this debt snowball method.

Yeah, so the other half of the authors, and really it's almost evenly split, say that you should

do something like the debt snowball, the debt snowball method is basically take the debt that has

the smallest balance and focus your energies on paying off that debt, because when you zero out of

debt account, that is going to give you a shot of motivation, and that is going to help you finish

your debt repayment journey. And so Dave Ramsey says, I know that mathematically this is not the

optimal thing to do. This is going to cost you more money relative to if you concentrated on

the highest interest rate debt. But he says, you know, this is all about behavior change.

You need to have these quick wins in order to stay motivated. Otherwise, you're just going to give

up and that's going to cost you more money down the road. Here is Dave Ramsey himself from the Ramsey

show. I understand the debt snowball is not mathematically correct. And I don't really care.

What matters is what works. And where does Morgan Housel fall on the debt snowball question?

On that argument, fully with Dave Ramsey. And I would just say, how many people has Dave Ramsey helped

out of debt versus the average academic economist? It's a million to one. Even if it is wrong on paper

and it makes economists wins, it's practical in the trenches. It actually works. There's probably

some equivalent to doctors who say it's fine to eat some twinkies once in a while. It might be even

fine to smoke once in a while because it's realistic. Even if it's not the right thing to do,

I realize that you're a human being and you are flawed like everybody else.

And therefore, this is just what works in reality. Not to split hairs here, but when you say

the number of people that Dave Ramsey has helped, what's the evidence for that? In other words,

yes, there's a lot of personal finance advice. But what do you know if anything about the actual

return on that advice? No, that's fair. I guess I'm taking a leap of faith that people could poke

holes into that a lot of book success and success in the content space is word of mouth.

So it's my assumption that Dave Ramsey sells a lot of books because people went to their cousin

or their neighbor or their brother or their coworker and said, this worked for me. It might work

for you too. The only way to sell a ton of personal finance books is through word of mouth.

And people only do word of mouth when it has been successful for them personally.

After I spoke with Housel, we did some research and found there is some evidence about Dave Ramsey's

impact. One of Ramsey's consistent messages is simply to spend less and save more.

The economist Felix Chopra examined what happened when Ramsey's radio show came into a new market

and Chopra found that among Ramsey listeners in those markets, exposure to the radio show decreases

household expenditures by at least 5.4 percent. So maybe we shouldn't be too quick to judge

Ramsey's debt snowball idea. Even the economist James Choi admits it may not be a terrible strategy.

I'm actually open-minded about this. I think the best diet is the diet that you can stick with.

And so the Mediterranean diet or the Atkins diet, there are a bunch of ways that you can

get to a reasonable place. So if you're the type of person for whom the debt snowball really is

motivating, then go with the debt snowball. Unfortunately, I don't feel like I've seen evidence

that really convinces me at the moment about the efficacy of one debt repayment strategy versus

the other. I didn't want to try to convince a major debt collection agency in Europe to test which

these strategies worked better. Unfortunately, I wasn't able to convince them to pull the trigger

at the end. So this is something I'm very interested in because I think this is a huge issue that

faces a lot of people. And how is it that we as economists don't know what is the most effective

way for people to get out of debt? I think it's just a huge gap in our knowledge.

Economists really hate what you call mental accounting, which is dividing money into different

baskets or setting up a vacation fund or whatnot. Most humans love mental accounting. Tell us

why we're wrong and you're right. Well, money is money is money. So if I have a dollar in my bank

account, I should be using that dollar for its best use. If that means that right now that

dollar is best used for my vacation to Hawaii, then we should use it for that. And if the dollar's

best use is to buy school supplies from our kids, that's its best use. What mental accounting does

is it tends to draw these rigid boundaries where a dollar that's being set aside for my Hawaii

vacation that can't easily be used for some alternative purpose. And so economists would say it

doesn't really make sense to divide up your wealth into these rigid buckets. I understand the logic

of that, but I think it fails to understand the psychology of most people in that there's such a

thing as peace of mind and there's such a thing as being able to sleep well at night and there's

such a thing as being able to actually take the vacation that you told your kids you'd be able

to take because you know you've put a few thousand dollars aside in a separate account. So do you

really not want any of us to do anything like that? You really think we'd all be better off if we

didn't do that. I actually have some sympathy for mental accounting. It does provide that peace of

mind that you are going to have enough money to go on that Hawaii vacation. It's just easier to

keep track of things and know whether you're on target. First of all, second, there is some evidence

from economists that having mental accounts helps motivate us to keep on saving because putting

money into this little bucket in my overall nest egg just makes really salient that hey, I have

a Hawaii vacation that I'm planning and this 20 bucks that I'm putting in this little mental

account is making that Hawaii vacation come a little bit closer to reality.

The concept of mental accounting was introduced by the economist Richard Thaler who helped create

the field of behavioral economics. Here is Thaler from a 2018 Freakonomics Radio episode called

People Aren't Dumb. The world is hard. This was not long after Thaler had won a Nobel Prize.

You get this call at 4 a.m. Chicago time and once they've convinced you this is not a prank,

they say, okay, get ready. There's a press conference in 45 minutes and the first question is,

what are you going to do with the money? And all I could think of was, well, to an economist,

this is like a silly question. To most economists, perhaps. Certainly to a non-behavioral economist,

it's a silly question. Because the answer would be, it just goes into the pool with the other money.

It's no different than any others that way. Right. I've thought that maybe the

hedonically optimal way to spend the money would be to get a special credit card,

the Nobel credit card. And then when I decide to buy a ridiculously expensive set of golf clubs,

hoping that that will turn me into a competent golfer, then I just whip out the Nobel card.

That might be a good idea.

So maybe mental accounting isn't such a terrible idea.

Here's another point of contention between most economists and most personal finance authors,

should investors go out of their way to buy stocks that pay dividends? James Choi again.

There's been this decades-long mystery, the financial economists have tried to understand

about why companies pay dividends at all and why people seem to like dividends.

I remember getting my first dividend deposit from the small amount of money I had in a brokerage

kind of the time. I remember feeling quite good about the fact that I had gotten this dividend

payment, but I didn't understand at the time. And it actually, I don't think I'd really understood

it until I had to teach a corporate finance course as a professor. If you have a stock, let's say

that the stock is trading at $10 per share. And the stock pays a $1 per share dividend.

As soon as that $1 per share dividend is paid out, the stock's price drops by a full dollar.

So now it's a $9 per share stock instead of a $10 per share stock.

And I don't think that that's well understood. People think that that dividend payment

comes almost for free. So I felt like I was making some financial progress when that dividend

deposit was made, but no, it just made a transfer from one account to another.

The author Morgan Housel, meanwhile, does see the appeal of dividend stocks.

It gives a tangible view to investors that things are moving at the company. I actually got

some cash paid back. Even if there is a more efficient way to return capital to shareholders,

I think from a psychological perspective, it just gives investors a tangible view of success

at the company that's hard to describe any other way. Where the authors and the economists agree

is that investing in the stock markets is a good idea. Even though many, many US households don't

own stocks. James Choi again. This so-called stock market non-participation puzzle has had a lot

of economists spill a lot of ink with theories for why. The leading theory is that there's some

kind of fixed cost of investing in the stock market. And so what this theory helps explain is why

is it that richer people are more likely to invest in the stock market than poor people?

Now, we are pretty sure that that theory is not a completely satisfying theory because even

Americans in the top 5% of the wealth distribution are not universally invested in stocks.

So there has to be something else that's going on. And I think that the most likely

force that is keeping a lot of Americans out of the stock market is that people are just too pessimistic

about the returns that are going to get on the stock market. So if you look at these surveys of

Americans, yes, then what is the chance that the S&P 500 or some other US stock market index

will go up over the next year? The answers they give are considerably lower than the historical

experience of the stock market. The economists and the popular book authors also agree that the most

sensible way to invest is to buy something like low-cost index funds rather than trying to beat

the market with individual stocks or paying a big fee for a fund that is actively managed.

The evidence, I think, is pretty strong that on average passive funds beat active funds.

That's because there are just a ton of costs associated with trying to beat the market, trading costs,

tax burden, and so on. And so both the popular authors and economists are pretty strong in saying

that passive management is the way to go. Now why is it that there's so much agreement? I think it's

because there is a lot of publicization of the statistics comparing passive index funds to

actively manage funds and showing that most of the time the index funds are beating the active

funds. We probably also have Jack Bogle of Vanguard to thank here. Jack Bogle was a pioneer of

the index fund, the first person to make them available to individual investors. He died in 2019

at age 89. We had him on this show a couple years before that in an episode called The Stupidest

Thing You Can Do With Your Money. He talked to us about starting Vanguard and how the smart money

kept telling him how stupid he was. The more descent I got, the more confident I was when I was

right on that kind of a contrarian person. So people laughed. There was this great poster that said

stamp out index funds. There's Uncle Sam with a cancellation stamp all over the poster.

Index funds are un-American. And they were considered un-American. That argument was what?

The argument is in America we don't settle for average. We're all above average.

But of course we're not all above average. The poster was put out by a brokerage firm. When I think

about the index fund, no sales loads, no portfolio turnover. You know, you don't buy and sell

every day like these active managers do. It's Wall Street's nightmare. And it still is. But

as Morgan Housel points out, not even the godfather of the index fund was fully rational with his

own investments. Jack Bogle's son became an active fund manager trying to pick winners rather than

tracking the market. And Jack Bogle, he invested in his son's fund. And when asked about that,

he said something along the lines of life as contradictory. That's just how life works sometimes.

And I love just that reality and that admission that even if this is what Jack Bogle

believed in his heart of how you should invest in low-cost indexing, he's going to invest in his

own son even if it seemed antithetical to what he was doing himself. That to me is a perfect example

of a real-world financial decision that sometimes doesn't make a lot of sense. And it's just

messier than you want to believe. But that's how people actually make decisions in the real world.

After the break, what's the biggest money mistake you've ever made?

They're extremely impractical and I'm just going to run out of money and they'll just be

collecting dust in my room. And if you'd like to hear some of the earlier episodes we've been

named checking on today's show, you can find our entire archive on any podcast app or at Frekenomics.com.

We'll be right back.

We asked you, our listeners, to share some of the biggest money mistakes you've made.

Here's what you said.

It took out way too much in student debt and I'm going to be figuring that out for the rest of my

working life, I think.

I used to spend toward the upper end of my credit limit and pay it off immediately thinking that

that would actually boost my credit score and I later learned that it actually does the opposite.

I couldn't figure out what was wrong until I finally discovered I remembered, oh my god,

I owe two dollars to this credit card that's like destroying my credit.

I lost 30 grand when I started investing or I was 20 and I was working in the oil field.

I do keep the majority of my money still in savings accounts today.

That's just like a genetic thing I think.

I wish I had understood earlier on how easy it is to obtain personal debt instruments

yet how hard it can be to get out from underneath them.

Hello, my name is Tate, I'm 12 years old and I live in a separate of a Minneapolis, Minnesota.

The money mistake I made was buying a lot of Pokemon cards.

They're extremely impractical and I'm just going to run out of money if I only buy Pokemon cards

and they'll just be collecting dust in my room so there's no point buying them anyway.

I asked James Choi the economist what he considers the most common money mistakes made by the average

person. I'd say two things that are somewhat related. One is just not having a rainy day savings

buffer. Life is just very, very difficult. If you have no buffer for these predictable

emergencies, you can get a flat tire, you have to patch a hole in your roof, whatever it is,

just to have a couple months of income at least salted away is a pretty high priority. A lot of

Americans don't have that. A lot of people would say, what are you talking about? You're an

economist at Yale, which is a great job. Your wife is a physician. You guys are in really good

shape financially. A lot of people can't even start to think about having a rainy day fund because

look, we know what wage stagnation is looked like over the past 20, 30 years. So a great many people

are just not able to even get on solid ground much less get their rainy day fund. Look,

everybody wants to have more income than they do. But if we just look at Americans in the 1950s,

we had much lower income in the 1950s than we do now. Personal savings rates were a lot higher.

Or you can look at China where their per capita GDP is a fraction of what ours is. Yet you see

personal savings rates in 30, 40, 50 percent ranges. So it really is about what standard of living

do we find tolerable? We know that there's only so many dollars that are going to come

into your life. And so the question is, do you deprive yourself now or do you deprive yourself

later? Maybe it's better to have a moderate level of deprivation both today and tomorrow rather

than having very little deprivation today and then a lot depravation tomorrow. Why do people

save so little? Is it simply because there are so many fun things to spend money on today,

much more than there was in the 50s? I think that's one of the great mysteries of our economy.

Now the optimistic way to look at the lower savings rate is to say that our social safety net

is much more developed now than it was in the 50s. Our financial system is more developed now.

And so you can get loans in a tough spot. You get better insurance than you did before. And so

there's less of a need to engage in precautionary savings now than you did in the 50s. And so that's

we save less. And that's why we save less than the Chinese because the Chinese don't have

merely is developed an economic system in a social safety net. So they have to save more. So that's

one perspective on it. Another perspective is, hey, we just made it a lot easier to tap your home

equity. We made credit cards a lot more available. Companies have gotten a lot better at marketing their

goods than they used to be. And so maybe it really is about greater temptation in the economy now

than there used to be. I don't really know the answer to this. And then you were about to give me

kind of big common mistake number two. Common mistake number two is just having too large

of a fraction of your monthly income tied up in what economists would call a consumption commitment.

This is like a rent payment or mortgage payment or private school tuition where basically there's

no give in that spending category over the short term. Now what does that do? It means that if you have

any sort of negative economic shock in the short term, it becomes very difficult for you to make

a budgetary adjustment. And that's how a lot of people get into trouble. So a lot of these

authors will say you should not have more than 50 to 60% of your income committed to inflexible

spending. And your number then would be what? I think that that's probably pretty sensible.

What you see in the data is that there are a bunch of Americans that live paycheck to paycheck.

And that they also have significant illiquid assets. So this is kind of the paradox of you live

in this beautiful home. You have a six-figure income. And yet you're out of money at the end of

the month. This is a phenomenon that economists call wealthy hand-to-mouth. These are people basically

who are house rich cash poor. And I think it's a pretty stressful way to live.

This made me curious to know how Morgan Housel, the author of The Psychology of Money,

thinks about his housing costs. My wife and I paid off our mortgage when we had a three percent

30-year fixed-rate mortgage. It is the worst financial decision we have ever made, but the best

money decision we have ever made. When Housel says it's the worst financial decision,

that might need a little explaining. A mortgage with three percent interest is considered very

attractive. When a bank lends you money that cheaply, not only do you get to live in the house

while you pay it off, but whatever leftover money you have can be invested in the stock market,

which historically pays out well above three percent. So you get to use money from the bank,

which it got from the U.S. government, even cheaper. And you can grow your money, plus you get

a tax break on your mortgage payment since the government likes to subsidize home ownership.

That's why most people consider a low interest mortgage to be a great thing. And certainly

worth keeping if you have one, but not Housel. On paper, on a spreadsheet, it's the worst thing

we could have possibly done because it's basically free money that we gave up. In the real world,

in our household though, there is nothing we have ever done with our money that gave us more joy,

more sense of freedom and independence and stability for our children than doing that thing.

I have so many friends who even when I frame it exactly like that, they say, I still don't

understand why you do it. And I would never do it. And I'm saying, that's great. I know it doesn't

work for you, but it works for me. So what's the emotional upside for you for having made that

decision that most economists and even many financial advisors would advise against?

Rather than trying to maximize the ROI on our capital, the return on investment,

we are trying to maximize how well we sleep at night. Other people I know would disagree with that.

They have a different personality, a different risk tolerance. But for us, it was not about making

the spreadsheet happy or making sure all the numbers lined up perfectly. It was, how can we use

money as a tool to make ourselves happier and give us a sense of independence, which is always

what I've wanted to chase. Rather than just trying to maximize return and generate the highest

network, all I really wanted out of money was a sense of independence and controlling my own time

and paying off our mortgage did that. What was it about having the mortgage that led you to not

sleep well at night? I think it was probably a simple idea that every dollar of debt you own

is a period of your future that somebody else has control over. I think what you're trying to get,

even correct me if I'm wrong, is trying to explain what we did in rational ways. When I fully admit,

it was not a rational thing to do. It just made us feel good, even though I can't explain it

on a spreadsheet. Right, because on the rational side, the economists would say, well, Morgan,

what about opportunity costs? Let's say you owed the bank a million dollars, and rather than spread

the remainder of that mortgage out over 30 years, you're saying, no, no, I'm going to take a million

dollars from our investment account or checking account, send it to the bank, pay off the note,

and now I own the house, but now you don't have the million dollars. I understand why that's a

reasonable versus irrational choice. What I don't understand is how in your mind, that creates more

opportunity when you're giving up the money that you had. So many of the most important things

in finance, and this is true for a lot of areas in life, are things that you cannot measure.

We paid off our mortgage five years ago. Every single month, on the first of the month,

I have this little grin on my face of like, this is mine. I don't owe anyone for this saying,

this is my house. We now have two kids. And I think as a provider, having that extra sense of

stability for my family, that no one can take this house away from us. This is our house.

Having that sense of stability gave me a sense of happiness and fulfillment that is very hard

to put into numbers or even put into words, I would say.

The economist James Choi doesn't have a mortgage either, but that's because he doesn't own his

home. I'm a renter for life, so I do not have a mortgage. There is this popular notion that

renting is throwing your money away. And that just can't be true at a well-functioning market.

So to just get out a little bit, what exactly are you doing when you buy a house?

You're just pre-paying all of the rent that the house would have commanded over its entire

working life. Are you going to pay this in monthly increments or are you going to pay it all up

front? It's a little bit more complicated than that, but that's the basic intuition and so in a

well-functioning market, the marginal person should be indifferent between buying and renting.

To me, one of the biggest differences is when you own some place, you feel totally different

about the place and you treat it differently. You invest in it differently, you decorate it differently,

you have a different relationship with your neighbors and your community and so on.

That's purely a psychological benefit, but can't you put that in the plus column for owning versus

renting? Absolutely. I mean, it goes both ways. So on the one hand, nobody ever changed the oil

on a rental car. Right. So you for sure are not going to take care of a rental property as well

as you would for a home that you own on your own. So in that sense, there's more wear and tear

on rental properties and so that's going to raise rents relative to if the thing was owned.

On the other hand, there is this psychological pleasure that people get from this notion that,

hey, I own this place that I'm living in and so if there is a real psychological pleasure,

it means that people are going to pay more to be able to own. Well, if you're paying more for

the property, that's going to decrease the financial returns to owning the property down the road.

So I think it's not really clear whether financially it's better to rent your own.

So you're never going to own a house. It sounds like, well, I get zero psychological satisfaction

out of the thoughts that I'm owning the place that I live in. So I'm kind of a weirdo in that way

and my wife's the same way. This may be the biggest difference between the popular finance authors

and the economists. Many economists as James Joy admits are kind of weirdos.

Personally, I love weirdos, all kinds of weirdos and that includes economists for sure,

but it may be that for something as important and intimate and confusing as money,

your money and your family's money. Yeah, maybe economists aren't the first place you should turn.

I found that the concluding paragraph of James Joy's paper summarizes economist weirdness

quite well. I asked Morgan Housel if I could read it to him and hear his response.

Okay, he writes in the conclusion, popular financial advice can deviate from normative economic

theory because of fallacies. Response there? I'd say because of reality. This is the word I would

change there, but he writes, popular financial advice has two strengths relative to economic theory.

Do you have any comment on the amazing fact that the popular advice made actually have two strengths?

It has strengths because it's realistic and people actually pay for it and actually read it

versus academic papers and nobody reads first strength, he writes. The recommended action,

meaning in the popular finance books, is often easily computable by ordinary individuals.

There is no need to solve a complex dynamic programming problem. People are not calculators,

they're storytellers. They need a couple of lines that make sense to them. That's how people

think about politics. It's how they think about relationships. It's how they think about money.

Second, he writes, the advice takes into account difficulties individuals have in executing a

financial plan due to, say, limited motivation or emotional reactions to circumstances.

Therefore, popular advice may be more practically useful to the ordinary individual.

That might be the best sentence in the entire paper. There is one more sentence, I'll just run it

by you. Developing normative economic models with these features, meaning the features of the

popular advice, rather than seeding this territory to non-economists may be a fruitful direction

for future research. What do you think he's really saying there? I think he's saying if academic

economists took the approach of understanding how people actually make financial decisions,

what they actually do versus what they should do, they would get much closer to reality.

I was thinking he was also saying, oh, man, we could write books that sell a couple million copies,

too, if we could develop, quote, normative economic models with these features. Do you feel insulted

by the argument he's making in this paper? I've not insulted, but I'm not surprised.

I'm not surprised that people who are very highly credentialed are very intelligent and

have spent their lives devoted to one sphere of finance, view that sphere as superior to other people

who are less credentialed, less educated, and are promoting advice that they view as wrong.

And I'm not surprised by it. I just don't think it's practical in the real world.

On this point, the intelligence of economists, I wanted to go back one last time to James

Choi. How smart do you have to be in the modern world to be good at personal finance?

Smarter than me. Okay, so that's scary. You're a PhD economist, and wouldn't the better answer be,

oh, no, no, no. You don't have to be smart. The system is set up so that anybody can manage your

personal finances well. Wouldn't that be the better answer rather than you have to be really,

really smart to figure out all this complication and this massive set of options and possible wrong

decisions? Well, I think that it's actually not that hard to get to some places reasonable.

What's really hard is to get to the optimal solution. I mean, life is complicated. And there are

so many factors that our economic models don't really take into account because they are too

complicated. They are too person specific. They are these Byzantine rules that we've created as

a society in tax code and all these institutions that are interacting with each other. So to really

get the optimal solution, I think it's almost hopeless. But to get somewhere reasonable where you

have a comfortable life and you're not worried about money all the time and stressed out, I think

that's pretty doable even for the ordinary person. What do you think? Is it pretty doable for the

ordinary person? Is it pretty doable for you? I hope so. I also hope this episode may have helped

you think about how you think about money. Thanks much to James Choi, Morgan Housel, and everyone who

sent us voice memos about their money stuff, especially Tate, who sounds like he's kicked the

habit of spending all his money on Pokemon cards. We will be back next week with a new episode.

Until then, take care of yourself. And if you can, someone else too.

Freakonomics Radio is produced by Stitcher and Renbud Radio. You can get the entire archive

of Freakonomics Radio on any podcast app if you would like to read a transcript or the show notes.

That's at Freakonomics.com. This episode was produced by Alina Kulman,

and updated by Delvin Abouaje. It was mixed by Eleanor Osborne. The Freakonomics Radio Network

staff also includes Augusta Chapman, Ellen Franklin, Elsa Hernandez, Gabriel Roth,

Ilaria Montenancourt, Jasmine Klinger, Jeremy Johnston,

Teo Jacobs, and Zach Lepinsky. Our theme song is Mr. Fortune by the Hitchhikers,

and our composer is Luis Guerra. As always, thank you for listening.

You don't want to rent spouses the way you rent. You're living place.

I think renting spouses is a terrible idea. Okay, good. I'm glad that's

firmly established.

The Freakonomics Radio Network, the hidden side of everything.

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