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Why 'Personal Finance is Personal' is a Dangerous Quote

May 5th, 2014 by 
PK

There is no worse dodge in Personal Finance than the sentence "Personal Finance is personal". While it's true that all of our situations are unique, the systems and processes you'll learn by taking control of your finances are universal.

Can you buy a Ferrari because personal finance is personal?
Sure I'm in Debt... But My Emotions Demand This! Personal Finance is Personal!

You're Using the Wrong Definition of 'Personal'

When you hear the phrase 'personal finance is personal', it's usually using the wrong definition.

Here's Google's first two definitions or personal quoting the Oxford Dictionaries for more:

  1. of, affecting, or belonging to a particular person rather than to anyone else.
  2. 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: the personal in personal finance references the first definition there, not the second.

There are very few processes that should differ from household to household. There are so few, in fact, that I'll write about them in the very next section.

Those parts?  Feel free to apply your personal differences.  Everything else is superfluous.

Fixing Your Personal Finances is a Solved Problem

There are two main sliding scales in personal finance each person needs to define for themselves: their Heterogenity of Risk Preference and any Comparative Advantages. Let's discuss both in kind.

Heterogenity of Risk Preference

Heterogenity of Risk Preference is a fancy phrase which says people value risk differently

This ties in mainly to what are known as discount rates, which are the amount that people discount future cash flows.

To put it another way, you and I have different goals and risk tolerance. To lay out a list, consider your answers to the following questions:

  • What timeframe do I have?
  • How old am I?
  • What's my age?
  • What is my goal?
  • How should I protect myself?
  • What are my odds of losing it all?
  • What's my downside even if I don't lose it all?

Because of your personal (definition 2 from above) experience, emotions, and situation, you'll answer differently here than most others.

Take, for example, stock markets and insurance contracts – they aren't zero sum games. The insurance company values risk differently than a suburban home dweller, for example. An insurance company can diversify in a way a typical homeowner can't.

Certainly, emotion is also a factor here. It affects perceptions of the expected return and the odds of your projections coming to fruition. Of course, once you have those numbers in mind... math doesn't change based on your mood.

In short though, risk preferences mean different situations call for different strategies. Since your risk preference differs from everyone else, some of your approaches might differ from others.

Comparative Advantage

The easiest way to reason about Comparative Advantage is to ask yourself "what's your time worth?".

Take the CEO of a company and a first time homebuyer with a median income, both with cash flow problems. Both pay someone to take care of their front lawns. 

The Notorious B.I.G. said, "Mo' Money Mo' Problems". More importantly for us, more money means different problems.

Here's a wild assumption about where first to cut: the CEO should sell her second vacation home to save 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 in Personal Finance you shouldn't be chasing nickels around $100 bills.

Personal Finance is Personal but 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.

Sure:

Argue all day about what a reasonable discount rate is. 

Discuss what needs protection and what insurance to buy. 

Reason about time frames and goals, and the risks of not reaching those goals.

However, don't dodge the personal finance medicine by exclaiming 'Personal Finance is Personal'. You need to approach your cash flow and debt problems rationally and blamelessly. 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. It won't blow up your budget, and you won't need to without blowing up your future!

Convinced there isn't much individual difference in the processes and systems you need for Personal Finance? Great! You can learn all the basics of Personal Finance in about an hour or two - go check it out.

Don't Quit Your Day Job...

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