Is Most Personal Finance Advice… “Wrong”?

I know what you’re thinking: Madam, you’d better not tell me I’ve been wasting away hours of my life reading and consuming your opinions for you to tell me that it was all bollocks. (Yes, in this hypothetical, you’re British.)

But if you exist in the physical realm, you’ve probably noticed something: We don’t live inside the cell of a budget tracking spreadsheet (despite my most earnest efforts; here’s hoping the metaverse can deliver).

I can plot out the next five years of my life neatly in the Financial Independence Planner, full of Future Value formulas, average returns, and estimates about income increases—but it’s mostly an illusion that provides a sense of control. If it encourages me to stick to the plan, wonderful! 

But there’s a problem with “the plan”: The human psyche. 

We don’t live in Excel World. We live in the Real World (no, not that Real World). And in the real world, people behave irrationally.

Renting vs. buying

A few months ago, I released a podcast episode about the “rent vs. buy” calculus in 2022. The math it suggested to prospective buyers was simple: to determine whether it was more financially prudent with current interest rates for you to (a) buy your primary residence or (b) rent one instead, and invest the cost difference in something else. 

The intent was to simply flesh out and compare the two paths. Assess the opportunity cost. Look at the outcome. Decide. Easy, right?!

While the example generally showed how the “rent and invest” camp often surpasses (or, at the least, keeps up with) the net outcomes of the “buy” camp in many parts of the country, there’s one piece of pushback I hear every time I dig into this:

“But most renters don’t invest the difference. They just spend the money. Renting instead of owning and not investing the difference is a losing proposition, and that’s how this plays out in reality most of the time.”

This roughly translates to: But Katie, these people don’t live in a spreadsheet. They live in the real world. 

A home is sometimes called a “forced savings device” for this very reason. And—fair!—I have no idea if someone weighing these options is going to actually institute either path “correctly.” It’s hard to quantify the error rate for ~human deviation~ in a breakdown of this kind if Melissa the Renter forgoes one month of investing to buy a pair of Chanel shoes (*sheepishly shuts closet door*). Melissa lives in the Real World (and, evidently, a rented home).

So is it true? Do most renters not invest the difference? If “renting and investing” were both lucrative and common, we’d expect renters to have net worths that surpassed homeowners—but according to Pew Research Center, 96.1% of people in the “top 10% of net worths” are owners, not renters. 

(Though I’d argue this invokes a causation vs. correlation argument that would titillate my Econ101 professor—put simply: Homes don’t make you rich, rich people just buy homes.) 

That said, it begs the question: If you know you don’t have the discipline or education to invest in the stock market every month while you rent—even if it’s the cheaper and more lucrative path—should you work on the discipline? Or should you just buy a home instead?

Melissa the Renter wouldn’t have the option of pausing an investment contribution to buy shoes if that payment was going to her mortgage lender. 

Sure, a comparison that occurs in a perfect mathematical vacuum may say it’s suboptimal because 75% of that “forced savings” monthly PITI payment is going toward unrecoverable costs (not equity). But is it still the better course of action if the other 25% is building equity, if the alternative use of those funds would’ve been spending anyway?

How much weight should we give our psyche (or other external factors) in these types of decisions?

Investing

Another popular example? Me, constantly beating the diversification drums.

While I can sit here and point to historical examples wherein adding diversification beyond the S&P 500 (Emerging Markets! Small Cap Value! Global Markets ex-US!) created outsized returns over time within spreadsheets and flawless backtests, your average investor doesn’t live inside a backtest. They live in the real world, where they need the confidence to assemble a more complex portfolio and stay invested in it long enough to reap the rewards.

Even if we can see that buying and holding a diversified portfolio of 8–10 index ETFs historically provided superior returns compared to a portfolio that only held one ETF, does it even matter if we can’t “hold” long enough to get them?

If your average investor isn’t prepared to stomach years—sometimes decades—of underperformance in some categories, it’s possible they’ll sell (out of frustration, or to get their hands on some cash), stop contributing (out of hopelessness), or never start at all (out of confusion). 

Surely we’d prefer investing with imperfect diversification to not investing at all, if making something so simple that it’s a no-brainer (buy one index fund and move on!) is the difference between someone investing and not investing,

Should we try to change our mindsets, or tailor our behavior to fit reality for the best outcomes?

Debt paydown

Debt sparks a lot of these “perfection” vs. “reality” debates:

• The “pay off all debt before you invest” or “make the minimum payments and invest” conversation is never-ending; the reality is making extra payments on low-interest debt is suboptimal when you could make minimum payments and invest the difference in the stock market. Consider this wild example from Mrs. Dow Jones, wherein Adele used a mortgage to buy a home and is paying a whopping $37 million in interest. But, borrowing the bank’s money enables her to invest her own money—and will likely earn north of $300 million if she stays invested (…yeah). Pay $37 million to make $300 million? Sounds like a good deal to me.

• The “start with the smaller amounts of debt and work your way up” vs. “start with the highest interest rate and work your way down” debate is a favorite between the Dave Ramsey Crew and pretty much everyone else, since starting with the higher interest rates first means you’ll pay less in interest overall, but starting with the smaller amounts builds momentum.

The mathematically sound answers are obvious. Leverage cheap debt. Pay off high-interest debt first. 

But if someone’s version of “make the minimum payments and invest” is a half-assed attempt wherein—most months—all the extra money just gets spent anyway (whoops!), well…that’s no longer as optimal for paying off the low-interest debt faster. 

If your version of “starting with the highest interest rate” becomes overwhelming because it lacks the momentum and psychological excitement of starting with the smallest amount and rolling all your payments forward—so much so that you stop altogether or disengage—that’s no longer better than just starting with the smallest balance and paying more in interest.

Should we opt for momentum to help guide our behaviors, or always prioritize the best potential financial outcomes?

The main question is: How much “human fallibility” should be factored into these debates?

Moreover…how do we quantify that? How do we bake human error and psychological irrationality into financial models? 

Maybe we can account for them (note to self, figure this one out), but maybe it’s better to avoid the “optimized” answer altogether and choose the one that fits our personality and commitment level better.

Maybe we run a “rent and invest” vs. “buy” calculation for ourselves and see that it’s actually more optimal for us to buy a home, but we aren’t yet ready for the commitment level and trips to Home Depot. Sure, we won’t have as much money later—but if the alternative is buying a home that we’ll foreclose on later, renting is still probably the better move. 

Maybe the calculus reveals that renting and investing will net us more money, but we haven’t shown a very strong track record of investing consistently and we fear our commitment level—then maybe buying is actually the better option for us and how we manage our money. 

If we find the thought of diversifying beyond the S&P 500 is enough to make us completely shut down (though, y’all—robo-advisors make it effortless for you) and we choose not to invest at all, maybe just buying the S&P 500 and calling it a day is the best decision for you. 

The answers that make sense in the spreadsheet can only take us so far when we live the rest of our lives out here in the real world. Plan accordingly.