I started teaching a personal finance elective in at SOM a few years ago, and at the time I needed a textbook. And so it seemed natural for me to look at some of the popular books that are out there, because there are a ton of them. As I was reading them, I thought, wow, there’s a lot in here that is totally at variance with what economists would say is the right thing to do. And there are some things in there that are just factually wrong.
At the time, it seemed to me that it would be quite interesting to do a more systematic study of what these popular authors are telling their readers, because there are millions of these readers out there, and they are probably more influential than economists are. Then I ended up picking the 50 most popular books that are out there according to the website Goodreads, and just did a systematic survey of what these books were telling their readers.
The earliest book in my sample was published in 1926: The Richest Man in Babylon. And I think this is actually one of the most influential personal finance books that has been published in the 20th century, because you see themes from The Richest Man in Babylon being repeated over and over again across many dozens of other books. That was the oldest book in my sample. And then there were books that were published in the 2000s as well. A lot of the books have some pretty common themes in their advice. It’s not like you read 50 books and they’re all telling you 50 different things. There are certain tropes that come up over and over again.
Probably the one that has the most significant impact on the reader’s welfare is about savings behavior. Economists would say that what you want to do is to consume, or spend a similar amount of money, in every period of your life. And the reasoning here is that the fifth slice of pizza is never as satisfying as the fourth slice of pizza, which is never as good as the third slice of pizza and so on and so forth. So there are diminishing returns to spending money in a given period. What that means is that instead of skimping and scrounging in one year and then overindulging in the next year, you should just consume the same moderate amount in both years.
While a lot of these authors, I think, have a theory that saving is like a habit or a discipline that you build. In order to save an adequate amount, you need to become the type of person that saves, and that it is psychologically difficult to not be saving hardly anything at all in your 20s and 30s and then suddenly turn on the savings jets and become a super saver in your 40s. It’s a different conception of human nature than the economists typically have, where the economists say, “No problem. In your 40s, you’re going to have high income relative to where you were in your 20s and 30s. So boom, you can just start becoming a super saver at that point in time.”
The popular authors are trying to make some concessions to limited willpower, limited motivation, limited ability to stick to a plan. So there are things like the debt snowball method, which says, “Don’t focus your energies on paying off the debt that has the highest interest rate”—which would be the cost-minimizing strategy that economists would say that you should follow. Instead, you should focus on paying down the debt that has the lowest balance, because if you can zero out a particular debt balance, that’s going to feel like a win. And if it’s going to motivate you, it’s going to help you remain on your debt repayment plan.
So it’s really about behavior change and what’s necessary to keep you on this plan rather than strictly minimizing costs, maximizing the amount of money you have to spend on yourself. I don’t know of any scientific evidence that I found compelling that the debt snowball method is actually more effective at getting people to pay down their debts. I think it’s an open question.
There is a good deal of pep talk motivation. I really liken it to the diet industry. Of course, there is an enormous industry surrounding losing weight, getting in shape, that sort of thing. The basics of exercise and diet are pretty simple, but it’s just about, how do you package that in a way that makes people feel motivated and makes people feel like they can change. I think that’s a big part of it, that personal charisma, the stories that the author tells, the narrative that they craft.
I think that there’s a really interesting area of research to be done by economists, by university professors, on what actually works for people in the real world. What kind of plans can they stick with and really allow them to persist in some financial management plan that gives them something reasonable at the end of the day?