There is no worse dodge in the entire Personal Finance universe than the sentence “Personal Finance is personal!” being used to excuse any sort of non-ideal behavior.
The simple fact that “Personal Finance” contains an adjective encourages certain folks to think that anything they do is a great move for their, well, personal finances. Nothing could be farther from the truth. Truth is, the important word in that phrase is not ‘personal’… it’s FINANCE, implying that the entire exercise is wrapped up with the unfeeling rationality of a little universal truth known as “Mathematics”.
They’re Using the Wrong Definition
Orwell would have a field day with the sloppiness of the language we use in Personal Finance. It mostly boils down to acolytes in the field using the wrong definition of Personal. Here’s Google’s first two definitions quoting the Oxford Dictionaries (that’s what the site calls itself – go yell at them) for more:
- of, affecting, or belonging to a particular person rather than to anyone else.
- of or concerning one’s private life, relationships, and emotions rather than matters connected with one’s public or professional career.
Here’s the thing: Personal Finance references the first definition there, not the second. There are very few things that should change from household to household – so few, in fact, that I’ll write about them in the very next section.
Those parts? Feel free to apply the dodge. Everything else is superfluous.
As my co-writer would say (usually about people not playing Basic Strategy in Blackjack): “People: this is a solved problem!”
And it IS a Solved Problem
The thing is: it is a solved problem. There are two main sliding scales in personal finance each person should define for themselves:
- Heterogenity of Risk Preference – this is just a fancy phrase which says people value risk differently. This ties in mainly to discount rates – the amount that people discount future cash flows (due to, say, inflation or the probability their assumptions will hold up). For our purposes, this would factor in things like “what timeframe?”, “what’s the expected return?”, “what’s my age?”, “what’s my goal?”, “what needs protection?”, “what are the odds of the return being delivered?” and “what’s the downside if it isn’t?”. In the same way that stock markets and insurance contracts aren’t zero sum games (the insurance company values risk differently than a suburban home dweller), risk preferences mean different situations call for different strategies. Now, don’t try to read emotion as a major factor here – certainly it affects perceptions of the expected return and the odds of it coming to fruition, but once you have those numbers… math doesn’t change based on your mood.
- Comparative Advantage – Or, formulated for a PF crowd – “What’s your time worth?”.
Here’s a simple example: pretend you’ve got a CEO and a first time homebuyer with a median income, both with cash flow problems. Both are paying someone to take care of their front lawns. Here’s the thing: odds are, the CEO should sell his second vacation home to save himself a mortgage payment, while the new homeowner should be cutting the lawn himself. The CEO’s lawn service can trim a lawn at a lower marginal cost than the CEO can – the CEO can trade that time for making a spreadsheet listing where his cash is going! As the philosopher Christopher George Latore Wallace once stated, “Mo’ Money Mo’ Problems“. Certain levels of income mean solutions will be different and considerations will change. The CEO may have many problems, including a $5 a day Latte habit, but Personal Finance does mean you shouldn’t be chasing nickels around $100 bills.
Seriously… Personal Finance is Personal? Yeah, and Math is Universal.
I’m sure you can come up with other factors which might change from household to household, but there is no denying that risk preferences and comparative advantage are the main factors. Any other scenarios you try to formulate (“what about a new baby?”, “what about the newly married?”) merely change your risk preferences and force time to be allocated to different things.
Here’s what it boils down to: argue all day about what a reasonable discount rate is. Argue about what needs protection and what insurance to buy. Argue about time frames and goals, and the risks of not reaching those goals. And, of course, once you’re cash flow positive and on your way to financial independence, you can reasonably do things you wish you could have done before without blowing up your future!
If you define yourself like this: “My time is worth $500 an hour, and I’m 100% sure I can return 7% a year investing.” Well, buddy, keep your lawn service, keep buying lattes, and do not pay off your primary residence’s 2.875% mortgage (well, not until we look at the alternatives). We’ll find a better place to make up the gap!
If you define yourself like this: “My time is worthless, stocks are pointless, and my best option is a 1% savings account.” Okay pal, well in that case continue paying off your 3% student loans and making toothpaste from scratch. Thank you for rationally defining this, we will get along just fine – but let us try to persuade you otherwise!
But don’t hand-wave off buying that $42,000 new car when you’ve already got $53,567 in consumer debt and cash flow issues by tossing out that in-artful dodge “I disagree! Personal Finance is personal!”. Like a hamster in a wheel, spinning and looking for a good reason for your behavior: you’re still in the same place, except a bit more tired and more unfit to actually solve your problems. Oh, and if you were trying to keep up with your coworkers? Well, it backfired – your new car just signaled to your boss that you’re being paid plenty, thanks for playing!
If you’re not willing to approach your cash flow and debt problems rationally, DQYDJ isn’t for you, sorry… you will get no sympathy from us with your “Personal Finance is Personal” chant. Don’t bother tuning in next time, for our amazing follow up – when we introduce an even better adjective to describe Personal Finance!
Okay, we’ll do it now: easy. You can learn all the basics of Personal Finance in one hour.