WSJ Article on New Advice Books

Today’s Wall Street Journal has a great item on the wave of new personal finance books now hitting the shelves and how the tone has changed from how to get rich to how to avoid going broke. In fact, it is more than tone, the content has shifted. There’s a great skewering of David Bach in the last few paragraphs for nearly pulling a 180 on his advice about home financing.

Further evidence of my thesis that these books just serve up what the readership demands, rather than any sort of objective reality.

Not Profiting on Home Improvement

WalletPop’s Zac Bissonnette has a great post on what a poor investment home remodeling is. Every year the folks at Remodeling Magazine (yes, really) publish a survey of the impact on a house’s value of various types of home improvements. Helpfully, they do this as a percent of what was spent, so if you blew $20,000 on a new bathroom that only increased the value of your house by $15,000, then that’s a score of 75%.

The survey breaks out 19 types of projects, across nine regions. Most of the recoup values are in the 60%-80% range. The best from this year seems to be the 97% of your money you get to keep if you are adding a wooden deck onto a midrage house on the Pacific Coast. As far as I know, the survey has never found a value over 100%.

To be fair, this does not quite mean that all home improvements are money losers. These are averages, so almost half of those West Coast decks actually did add value. And the survey only covers relatively large projects, the kind for which you would hire a contractor. If you ask a good real estate agent how to make your house more valuable he will suggest cosmetic improvements, e.g. a new paint job. I am guessing that those sorts of fixes really do turn a profit.

But the basic observation, that home remodeling is a terrible investment, still holds. In a more perfect world, this would be so obvious that nobody would bother to mention it. Buying something at retail and hoping to sell it used at a profit, essentially what we are talking about here, is rarely a winning strategy.

But as Bissonnette points out, there is an entire category of cable TV shows based on the premise that you can make money remodeling. How can it be that home experts on responsible networks can advocate something so contrary to reality?

Because these are only TV shows. The people who make and broadcast TV shows are successful if people watch the shows, not if the shows are factually correct. And people want to see video of gleaming new kitchens and hear what a great investment they are. Ending a show saying “And Bob and Sue’s new sun room only vaporized $10,000 of their net worth.” would not help ratings.

Which brings up an important point about personal finance advice. We all make an unspoken assumption that successful givers of advice must give good advice, otherwise people would stop listening. This is not (quite) true. Popular givers of advice tend to get that way because they say what their audience wants to hear and wants to believe is true. People want to believe that they can become millionaires relatively easily by skipping the lattes or that they can work only four hours a week. That doesn’t mean it’s true.

Big Ben Franklin

The blog Get Rich Slowly had a post two days ago celebrating Benjamin Franklin’s 303rd birthday. I’m sorry I missed it. (The date; not so much the post.) Little Ben came into the world right here in Boston, about where the Claire’s store is now.

I’m a big fan of Ben’s, although not for the reasons that attract the Get Rich Slowly crowd. (And wouldn’t calling the blog Get Rich Slow be more parallel with get rich quick? It’s a great name anyway.)

Franklin was a very successful entrepreneur on what was then a wild frontier. In his spare time he was the leading American statesman and diplomat of his generation. And that stuff they told you in school about his discovering electricity is more true than not. Three centuries later, one end of your AA battery is labelled “+” and the other “-” because that’s what Ben decided to call them.

But for the adherents of the frugal faith, Franklin is known for the aphorisms he published in his Poor Richard’s Almanack and rehashed in Father Abraham’s Sermon, a.k.a. The Way to Wealth. These were wildly popular works in 18th Century America. You might say they are the beginning of our personal finance advice genre.

The Way to Wealth is all the more convincing because it is from a notably wealthy man. But just like the personal finance gurus of today, Franklin did not get rich from following his own advice so much as from selling it to others. It is not clear how frugal he was in his own life; he certainly understood that making a good show of being thrifty was good for business.

It is clear that getting rich slowly and quietly was not his thing. At 17, he skipped out of his apprenticeship to his brother in Boston (after learning the printing trade) and settled in Philadelphia. He fathered an illegitimate son that same year. By age 24 he was publishing a newspaper of his own and agitating for political reform in Pennsylvania. He managed to found most of the civic institutions the city needed, including a university, a public library, a volunteer fire department, and the militia. And then on to a bigger stage. In 1757 he got himself appointed the colony’s representative in London. He stayed there more or less continuously until the revolution broke out in 1775. If things hadn’t gotten nasty he probably would have lived in the big city for the rest of his life. His wife was back in Philadelphia the whole time.

Like I said, I love the guy. But those aphorisms of his, many, if not most, borrowed from others, may not relate all that well to his life. He did not, it bears pointing out, ever sign his own name to them. Get Rich Slowly quotes one of them as “Who is rich? He that rejoices in his portion.” That’s not in The Way to Wealth. As far as I know, it is in one of the 25 issues of the Almanack, but it’s originally from the Jewish Mishna, quoting Shimon ben Zoma two thousand years ago. (Pirkei Avot 4:1) Authorship aside, I am pretty sure that in real life my man Ben was not the kind to be satisfied by what he had already.

Prof. Shiller and Financial Advice

Robert Shiller (he of Irrational Exuberance fame) has a column in today’s New York Times linking the current financial crisis with fundamental mistakes made by the financially illiterate masses. Well, golly.

I am a fan of Prof. Shiller’s. His books are worth reading (if a bit dense for the non-economist) and he is an engaging public speaker. He is one of the very few who can look at the global recession and rightly say “I told you so.”

But the good professor is still a college professor. Academics can be very smart and insightful but they tend to have difficulty with the realities of the world that the rest of us live in. Shiller’s basic suggestion is that some of the government bailout money be used to start “a major program to subsidize personal finance advice for everyone.” This, I suppose, because the Federal Government has such a stellar track record on education.

He cites a “paper” presented at a recent academic conference that he says shows that people who fail “financial literacy tests” tend “to make serious investment mistakes.”

First off, the paper looks like a PowerPoint presentation to me. Second, it doesn’t say much about bad decisions, in fact it concludes that the financial illiterates were no more likely to take out an ARM than a fixed rate mortgage. (Although they were a lot less likely to understand the difference.) And thirdly, the test of financial literacy is really just a few fourth grade math problems that happen to be about money. It’s not a literacy test, it’s an intellegence test.

So it turns out that dumb people sometimes do dumb things. Fascinating. I think the most important realization from this is that there are banks that will give a mortgage to somebody who doesn’t know the price of a $300 sofa marked down 50%.

What Shiller is missing is that there is no need to subsidize the production of personal financial advice. We’ve got lots of that already. Foolish choices were not made because of a lack of access to advice. They were/are made because of a lack of access to good advice.

Why This Blog

This is not an advice blog, really. It is a blog about advice, and as a side-effect it contains some advice of its own. But the main topic here is the advice given by others and how bad it is. And not just any advice. I mean to talk about advice on a single subject of almost universal interest: money.

Money, or to use its proper name, personal finance, is one of the major genres of advice in the media, up there with dieting and sex. Of course, I’ve never read a dieting book and I’ve never flipped through a sex manual without a smirk, so for all I know the advice given on those topics is similarly lousy. But I have read a lot of personal finance books, articles, and blogs, and I’ve even managed to sit through some TV shows and heard some rather tedious radio call-in shows on money. Some are better than others. Some have good production values and a few are even entertaining. But they all seem to fall down on content. The best ones give advice that is only approximately sound and the worst say things that are just flat out wrong.

My qualifications for giving personal financial advice, and for criticizing the advice of others, are thin. Then again, the qualifications of the established experts in this field seem no more substantial. Mostly, what they have that I do not is the circular proof that they are qualified to give advice because that is what they do professionally.

I am an unemployed finance guy. To be more specific, I used to run a hedge fund. (The fund’s end was not dramatic, BTW. No frauds or spectacular losses. We had a mediocre year and my partner decided he wanted to do something else with his life, so we closed up shop.) I studied economics at an Ivy League college, got an MBA in finance at another Ivy, and have the usual assortment of licenses and letters after my name. All told, I have spent twelve years being paid rather nicely to invest other people’s money. So listening to what I have to say about personal finance is not the craziest thing you could do, even if I do not have my own TV show. Yet.

Then again, I am unemployed. That’s not exactly a unique situation right now, particularly in my line of work, but still a person might reasonably wonder: if I was really as smart about this stuff as I apparently think I am, would I have the free time to write this blog? That’s a good question for which I have no answer. But it does bring up a fundamental difference between advice on money and advice on, for example, dieting and sex.

Writing a book or blog is a natural next step for a person who is very good at dieting or sex. There is only so much weight a person can lose and only so much sex a person can have. (So I am told.) Opportunities to do either of those things at a higher or more advanced level are limited. So sharing the secrets with others in exchange for fame/money is about all you can do.

This is not the case with money. A person good at money generally keeps working at adding zeros to his net worth until he can buy an island to retire to. So who, you might reasonably ask, writes all those books and gives all those seminars? People who are clever about money but so naturally generous that they want to share their insights with others rather than profit by them personally? Can I interest you in a bridge I have for sale over the East River?

There is another, much more serious, difference between advice on dieting or sex and advice on money. If the advice everybody got on dieting and sex was faulty, that would be somewhat unfortunate for the nation. We would be a little chubbier and a little less happy in bed. But if bad advice on money is widespread and followed we’re all in big trouble. If, to imagine a far-fetched example, millions of people were told to buy more house than they could afford, the inevitable housing price bubble might set off a crisis in the capital markets that could plunge the whole world into a recession.

Left wing types like to fantasize that the economy is controlled by a small and sinister elite. That might have been true somewhere at sometime, but it is very far from the reality of the here and now. Ours is an economy controlled by millions of ordinary people, each with responsibility for a tiny bit of it. If a lot of them do a bad job of running their slice of the pie, then we all suffer, even those of us who are clever and thoughtful about money.

The premise of this blog is twofold: that personal finance advice ought to be taken seriously and that it needs to be a lot better than it is now.