On Money and Psychology

One of several recurring sub-themes here at Bad Money Advice is that some givers of personal finance advice, particularly the mass market gurus, say things that can only be justified assuming an irrational audience incapable of acting in their own best interest.

Freud Note So, for example, when Suze Orman tells her readers that they should absolutely never borrow from their 401k account to pay off a credit card balance, I give her a hard time for giving terrible advice based on the assumption that her audience has no willpower and will merely run up the credit card balance again.

But when I criticize the gurus for giving bad money advice that is, in fact, bad psychotherapy, I do not mean that everybody ought to be able to behave in a perfectly rational manner around money. Quite the opposite. We are all merely human, not uber-logical Vulcans. We act sub-optimally around money (and everything else) for a variety of emotional and behavioral reasons.

But the Ormans and Ramseys of the world don’t make this situation better in the way they take psychology into account, they make it worse. First, they rarely disclose that the advice they peddle has a psychological spin. In moments of reflection they may remark that what they do is more about emotions than mere logic, but when giving advice they almost never reveal that what they are saying only makes sense in the context of some assumed shortcoming in the listener.

Indeed, they often concoct spurious arguments that attempt to justify the advice as being perfectly rational. In other words, not only is the advice not labeled as being for those who can’t manage the hard and logical path, it is falsely labeled as that logical path.

So Orman argues against borrowing from a 401k because it is "just too risky" in the current economic environment, not because she thinks you will be unable to resist the temptation to go deeper into debt. And when David Bach pushed the Latte Factor he didn’t say it is a small gain for a small sacrifice, and that is just part of being a responsible grown-up. He exaggerated the benefit so that even a caffeine addled slacker with neither foresight nor willpower could get excited about it.

To his credit, Dave Ramsey does admit, occasionally, that his snowball plan for debt reduction is “more concerned with modifying behavior than correct mathematics.” But he gets only partial credit. Using the term "mathematics" obscures the point that he is telling his listeners to do something that will cost them more money than taking another, relatively obvious, route.

My second objection to the way that the gurus deal with money irrationality is that they implicitly make the assumption that their entire audience shares the same foibles. Indeed, listening to them you get the impression that they believe these problems to be universal to the human condition. Ramsey does not argue that credit cards are dangerous for a few people, he argues they are a bad idea for everybody, himself included, and makes the extraordinary claim that rich people don’t use them. (Total Money Makeover, p.42.)

I believe that we are all imperfect in our money behavior, but that the nature and degree of this imperfection varies greatly from person to person and even from time to time. In contrast, the personal finance mainstream apparently believes that everybody is impulsive and lacks either the foresight or the willpower to save for the future and avoid going into debt frivolously. As an empirical matter, this is not true. Recent work has shown that there are sizable numbers of consumers with the opposite problem, that they save too much.

Moreover, by continually saying that being foolishly shortsighted is natural and ordinary behavior, the gurus reinforce that behavior. Everybody likes to be normal. Not paying off your credit card balance every month is a lot easier to rationalize if you have been told that this is what everybody else does.

Which brings me to my third and most important objection. The gurus presume that these bad habits are incurable. Learning to conquer your natural tendency to spend more than you have is impossible, so don’t bother trying. It makes more sense to hamstring yourself by limiting your future options, for example by not having a credit card at all or by paying down your mortgage early.

Hence, the root of my first objection, that the mainstream personal finance advisors rarely own up to giving advice that makes sense only if the listener has a behavior problem. If you think that these problems are universal and unfixable, then there is no sense in upsetting the patient by telling him that he is crazy. Better to use smoke and mirrors to make him think that your instructions are what a sane person would do.

I am not an expert in psychology so I am not going to express an opinion on how curable these problems are. But it seems obvious to me that many people who have trouble with this kind of self control could learn to act more maturely. And that that learning is not going to happen if those people are either not told that they have a problem or, if they are told, that the problem is a natural and incurable part of being human.

Telling a person with a spending problem not to own a credit card is like telling an alcoholic with a history of DUI not to own a car. Selling the car may be an immediate fix, and for some it may turn out to be the only thing that works, but it is both drastic and doesn’t confront the core of the problem. (And, of course, Ramsey thinks we are all alcoholics, so nobody should own a car.)

I believe that the primary driver of our personal finance problem is not psychology and behavioral flaws but sheer ignorance about the ways of money. Of course the psychological factors are real and important, but allowing them to dominate the conversation, allowing advice meant to counteract a behavioral problem crowd out simple rational advice, makes the situation worse, not better.

[That's Sigmund Freud on the Austrian 50 shilling note, BTW.]

37 Comments

  • By Dan O, June 15, 2009 @ 12:47 pm

    I definitely have heard a lot of finance advice lean towards what you’re saying – it’s more about the psychology than the money. However, it’s easy enough to simply ignore the junk you already know is bad, at least for me.

    For example, I’ve had credit cards for about 9 years, since my first year of college. Do I think they’re bad? No. I pay my bill in full every month and get rewards checks periodically. I’ve made well over $1000 on things I would buy anyway.

    Where it gets difficult is where the answer is unique to you. Should I take this money and save it? Invest it? Where? In what funds? These types of problems can usually not be solved in a blanket statement by a finance guru, but by a thorough analysis by a financial professional.

  • By Dave C., June 15, 2009 @ 1:34 pm

    On one hand, spreading your message to cover a wider audience (including both financial “alcoholics and the adequately educated) allows the Suze-Ramsey type much more chance for increased revenue. I imagine this is a common marketing/business problem for any media production.

    On the other hand, the ease to which you can publish your message on the Internet means that focusing your message to a specific and appropriate audience won’t necessarily increase your publishing costs (though it may reduce your revenue).

  • By Dangerman, June 15, 2009 @ 1:47 pm

    “First, they rarely disclose that the advice they peddle has a psychological spin.”

    That’s certainly NOT true of Dave Ramsey. Dave says almost every single episode that “personal finance is at least 80% emotional.” Frank, if you’re going to bash Dave this often, you really gotta listen to a few episodes.

  • By SJ, June 15, 2009 @ 2:46 pm

    wow… sweeet bill =)

    I think acknowledging the psychological elements is relatively new… And educating self in those areas is more… complicated. It’s more subtle then “supply and demand”, which by itself isn’t subtle lol…

    I think being perfectly rational about money and risk is impossible. However, make the right decision for semi-obvious cases, i.e. taking financing for a freakin’ ipod via an 18+% APR CC vs… waiting… isn’t even finance.

    It’s just self-control. We suck =)

  • By Rob Bennett, June 15, 2009 @ 2:46 pm

    I think that the basic problem is that what works from a marketing standpoint is often what doesn’t work in practice. All money advisors are torn between giving advice that works and giving advice that possesses emotional appeal and that thereby makes them popular.

    The solution is blogs like this one that call the “experts” on their nonsense. We need hundreds of them, in my assessment.

    The wonderful thing is that, once there are blogs in place calling the “experts” on their nonsense, they won’t be peddling nonsense anymore. If we adopt a practice of calling the experts on their nonsense, there is no longer much of a marketing edge in peddling nonsense. And I think that many of the “experts” would be thrilled to be freed to give better advice than what they feel safe giving today.

    What we have today is a vicious circle (bad advice makes one popular, which makes people ill-informed, which makes people emotional, which makes people desire bad advice, which means that giving bad advice makes “experts” popular). We need to replace it with a virtuous circle that works in exactly the opposite way (good advice makes people better informed, which makes people less emotional about money matters, which makes people better able to distinguish good advice from bad advice, which encourages the experts to give even better advice).

    It has to be the Personal Finance Blogosphere that leads this effort, in my view, because the general media is too financially beholden to the “experts” to be able effectively point out their weaknesses. Blogs could do it. But even in the Blogosphere people worry that telling it straight will cause those peddling nonsense not to like them and might result in them being “cut off” from the Big Shots and their Link Love.

    The root problem is really the idea that the Free Market always gets it right. The Market’s inclination is to tell you what you want to hear, not what you need to hear. The money-making thing in this field is often to give poor advice. We need a Free Market tempered by some integrity considerations. If the Blogosphere were to make serious efforts to incorporate some integrity considerations into the formation of the money advice it gives, that would change the history of personal finance, in my view.

    I think most people think that all this is so only to a small extent. I have learned different (to my great shock and surprise) over the course of the past seven years. I had zero idea how bad things were until I learned just how bad they are through personal experience.

    The good side of the story is that things are now so bad that even relatively small positive efforts would bring huge benefits.

    Rob

  • By Andy lapointe, June 15, 2009 @ 3:44 pm

    Entry-level money management for those in financial difficulty has much in common with weight loss. Merely having the proper diet/financial plan is completely secondary to the mental/willpower aspects of the program. You may be technically correct in your assertion that the Ramsey/Orman advice may not produce the optimal gains. That is secondary to providing a program that financially unsophisticated consumers can grasp and use to stay on track.

    I used a Ramsey-like approach to eliminating card student and auto loan debt and then used my cash flow to fund now-fat investment accounts. As I progressed, I outgrew the clumsy tools provided by Ramsey/Orman and evolved into more high-level financial advice.

    The advice you are criticizing is target appropriate. Relax, these “guru’s” are not competing with you.

  • By Andy lapointe, June 15, 2009 @ 3:46 pm

    Also, Dangerman is right. You do actually need to read Ramsey before you write a critique of him.

  • By Four Pillars, June 15, 2009 @ 4:20 pm

    I think a lot of bloggers are guilty of this too. They often spout out the “Credit cards are evil”, “Don’t buy a house with less than N% down” etc etc.

    Sometimes these mantras are taken from the gurus you mentioned and sometimes they just take it from their own situation (ie I can’t handle credit cards) and apply it to everyone.

  • By TJR, June 15, 2009 @ 4:44 pm

    Never underestimate the “psychological problems” associated with money.

    Sticking with your comparison, I have talked to alcoholics who went from drunk all day for years to sober, getting an education, building up a middle class existence and finally entering psychotherapy. Guess what they were by far the most proud of? Successfully becoming dry.

  • By Frank Curmudgeon, June 15, 2009 @ 6:26 pm

    I’ve read a lot of Ramsey. What I haven’t done is listen to hundreds of his shows, a failing for which I have only the lame excuse that it’s not broadcast in my area. In any case, I said in the post that he deserves credit for saying he believes it is all about emotions and behavior. I just don’t think that’s enough.

    And I am really getting tired of the defense of the gurus on the grounds that they are good enough for their audience and it’s not fair for me to hold them to the high standard that I do. Suppose you found out that your child’s kindergarten teacher was telling his pupils that the Earth was flat and that disease was caused by evil spirits. Would you say that’s okay becuase the teacher is so good at teaching ABCs and arithmetic? Or would you go straight to the principal to complain?

  • By Atticus, June 15, 2009 @ 8:45 pm

    I thought Suze Orman counseled against borrowing from your 401(K) because you borrow before-tax dollars and repay it with after-tax dollars (thereby incurring a loss equal to the amount you borrow multiplied by your tax rate).

  • By Frank Curmudgeon, June 15, 2009 @ 9:04 pm

    Love to see where she said that, if she did. It doesn’t work that way. From the 401k point of view, the loan is just another investment, i.e. the money doesn’t go away, it gets allocated to the “lend it to my owner fund.” From the owner’s point of view, it’s just another consumer loan, except that the creditor is the 401k account.

  • By IndependentOperator, June 15, 2009 @ 10:33 pm

    Frank, she says exactly what Atticus says in her book here: http://www.amazon.com/Money-Book-Young-Fabulous-Broke/dp/1594482241

  • By Frank Curmudgeon, June 16, 2009 @ 9:40 am

    And so she does, right there on page 101. Wow.

    I’m thinking of coming out with my own version: Frank Curmudgeon’s Money Book for the Middle Aged, Dull, and Comfortable.

  • By GPR, June 16, 2009 @ 10:19 am

    Frank, if you come out with that book you may discover very quickly why the popular gurus write the way they do. May I suggest instead: “The 23 Things They Don’t Want You To Know About Your Money.”

  • By GPR, June 16, 2009 @ 10:26 am

    “He exaggerated the benefit so that even a caffeine addled slacker with neither foresight nor willpower could get excited about it.”

    This seems to me the very definition of a good hook. Plus there are more caffeine addled slackers in the world than there are rational humans (67% more, according to my research).

    “Spend Less, Earn More” would be a boring book.

    I give this guy massive kudos for figuring out a way to sell something so basic. Of course, I admire the Jonas Brothers for the same thing. Awesome marketing!

    I hope someone else posts a comment soon. I keep showing up late to the party and I feel like I’m killing the posts. The Germans probably have a good word for this type of guilt.

  • By kmf, June 16, 2009 @ 11:31 am

    You end up paying tax twice on money that you repay to your 401K, once because it’s after-tax money, and then again when you withdraw it in retirement. Maybe not a dealbreaker for taking out the loan or not, but not completely irrelevant either.

    Of course if you lose your job while you have a 401K loan outstanding it becomes a distribution, that’s really the only argument Orman needs to make against 401K loans.

  • By Frank Curmudgeon, June 16, 2009 @ 11:47 am

    Money you use to repay a credit card loan is after-tax also. Would you feel better if instead of borrowing from your own 401k you borrowed from the one belonging to the guy in the next cube? Would it be okay if he borrowed from yours? He’s a good risk and will pay a good interest rate.

    The risk of losing your job and having to repay the loan (typically within 60 days) or declare it a distribution is real, but exaggerated.

    Orman doesn’t want you to borrow from your 401k becuase she assumes you will just blow the money on something and go deeper into debt.

  • By Kent @ The Financial Philosopher, June 16, 2009 @ 12:09 pm

    Great points, Frank (and everyone)…

    The Suze Orman’s of the world do not exist to provide useful information — they exist to sell books, or in the case of mass media, they exist to sell advertising.

    The answers to financial challenges (and other problems that primarily derive from behavioral issues) are best delivered and received from one source — the individual.

    Finding answers from outside of one’s self is nothing less than looking to BUY fish rather than learning HOW TO fish — to become self-serving.

    Suze Orman is simply supplying a demand and she knows that the mass audience does not want to look within themselves for the answers — they want Suze to tell them the answers.

    While she may tell people to “do it yourself,” she does not explicitly say (to my knowledge) to “THINK for yourself” and then proceed to help her followers acquire self-knowledge — to explain how to “think about thinking.”

    I recall seeing her on a talk show and an audience member asked, “Should I hire a financial adviser?” Suze replied, “Absolutely not! You can do it yourself!” The audience applauded their approval.

    My follow-up question to Suze, if I had the opportunity to ask on behalf of the audience member, was “How do you know this individual has the capacity or desire to plan and manage her own finances?”

    If she really intended to help people, I believe she would write herself out of a job.

    “Every one rushes elsewhere and into the future, because no one wants to face one’s own inner self.” ~ Michel deMontaigne

  • By Kosmo @ The Casual Observer, June 16, 2009 @ 12:28 pm

    When I first became aware of Ramsey’s system (notably the snowball method) I really didn’t understand the concept, because it seemed counter-intuitive.

    I understand that the system can work for some people (or even a lot of people) and that’s great, but, yeah, it would be nice if he made it a bit more apparent that there is a less expensive option.

  • By kmf, June 16, 2009 @ 1:03 pm

    “The risk of losing your job and having to repay the loan (typically within 60 days) or declare it a distribution is real, but exaggerated.”

    How so?

  • By Kent @ The Financial Philosopher, June 16, 2009 @ 1:52 pm

    The “double taxation” issue on 401(k) plans is a myth. I learned this the hard way years ago when I conducted 401(k) enrollments for a living and an employee of my client’s firm challenged me. As you might guess, I lost the challenge.

    Actually, the only portion that is really taxed twice is the interest — not the principal.

    A decent explanation of the double taxation myth can be found here: http://www.401kplanning.org/top-401k-planning-questions-and-answers/should-i-take-a-401k-loan-and-other-401k-loan-questions/will-i-pay-taxes-twice-on-a-401k-loan/

  • By John Buerger, June 16, 2009 @ 3:19 pm

    I am a Wealth Coach and CFP® fiduciary professional. This is one of the best thought out critiques of the “gurus” I have seen to date.

    Every person’s financial picture is complicated – with thousands of moving parts. Blanket one-size-fits-all statements do not serve people well for a number of reasons, the most important of which are outlined here.

    Financial and Economic Literacy are woefully lacking in the US. Debt is neither good nor bad intrinsically. It depends on how it is used/managed. To do that you need information, tools and an articulated strategy that you understand and can implement – a strategy that is built around your goals and dreams.

    No mass market guru is going to give you any of that. The price of their “advice” is cheap … very close to free. But you get what you pay for.

  • By Dangerman, June 18, 2009 @ 10:34 am

    @Frank “And I am really getting tired of the defense of the gurus on the grounds that they are good enough for their audience and it’s not fair for me to hold them to the high standard that I do. Suppose you found out that your child’s kindergarten teacher was telling his pupils that the Earth was flat and that disease was caused by evil spirits. Would you say that’s okay becuase the teacher is so good at teaching ABCs and arithmetic? Or would you go straight to the principal to complain?”

    I don’t think that’s a fair analogy.

    I think a more appropriate analogy would be if a teacher taught a high school student that gravity follows Newton’s laws. Not technically accurate, but good enough >95% of the time. The teacher is using a simplification that is generally accurate. If the teacher tried to explain General Relativity to the high school student, the student would be ill served.

    Same thing with you vs. Dave/Suzie: you criticize that they make simplifications that aren’t accurate for everyone. Blanket one-size-fits-all statements DO serve MOST of the people well MOST of the time.

  • By Andy Lapointe, June 19, 2009 @ 1:49 pm

    Curmudgeon: I am advocating teaching 2nd grade to 7 year olds. That is appropriate. Financial learning advances in stages like any other type of learning. Your advice is over the heads of beginners. Some people will never have enough of a grasp of finance or economics to pursue anything other than a simple plan. There needs to be financial advice for all levels. You can either dumb down your message or leave the entry-level to the Ramsey types.

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