You Don’t Need Advice From An Economist

Posted by TEBI on December 14, 2022

A common misapprehension about investing and personal finance is that, to be really successful at it, you need to be an armchair economist. At the very least, people assume, it pays to know what leading economists are saying about the global economy and the financial markets. In fact it doesn’t. Even a PhD in economic theory is unlikely to help you very much. Why? Because the best financial advice has nothing to do with economics. More than anything it’s about psychology.

There are hundreds of books giving financial advice. Some of them, like Robert Kiyosaki’s Rich Dad, Poor Dad have been incredible best sellers.  According to Publishers Weekly, Kiyosaki’s book has sold more than 44 million copies.

However, very few, if any, of these books have been written by economists. And recent research suggests why.

Theory and Practice

In a paper titled Popular personal financial advice versus the professors, James J. Choi from the Yale School of Management compared the advice given in 50 of the most popular personal finance books against mainstream economic theory.

What he found is that there are some notable differences.

For example, almost every personal finance author will subscribe to the idea that you should start saving as early as possible. Most recommended investing 10% to 15% of your salary every month from your first pay cheque.

Economic theory, however, would show that this isn’t optimal. It is more rational to save very little, or even nothing, when you are young, and to ramp up your saving in middle age when you are at your peak earnings potential.

The Real World

The reason for this isn’t that hard to understand: how much you need to spend should increase at a lower rate through life than your earnings power.

A rational person wouldn’t, for example, sell their Toyota and buy a Range Rover when they started earning significantly more. They would instead use that increased disposable income to channel into their investments.

In a theoretical model, this would actually result in more savings.

In the real world, however, this is very rarely a good idea. That is because, quite simple, people are not wholly rational.

This is reflected in the three reasons why advising anyone to start saving as early as possible is far better advice, even if it is theoretically sub-optimal.

Where Economic Theory Falls Short

 To continue reading, please go to the original article here:

https://www.evidenceinvestor.com/you-dont-need-advice-from-an-economist/