Earn What You Spend

The impetus for me to write about finance was simple -our society has a clear lack of basic financial literacy.  I want to do something to address this, and the first step in doing so is for me to flesh out my philosophy and understanding of the situation by blogging.  Then, I believe, I will be able to move more directly into action.

We continue to move in the direction of an “ownership society” - we can no longer rely on Social Security or the pensions and health care provided through our employers.  Our financial security is up to us to provide. 

An ownership society in which we dictate our own financial future is a great idea.  Yet in practice we are missing one crucial detail: the basic precepts of financial literacy.  If individuals possessed the education to enable them to make sound financial decisions, a move towards empowering these individuals with controlling their own retirement would be a wise one.  But even the savviest among us aren’t always sure of what to do with our finances.  We have to be sure we don’t put the cart before the horse. 

Robert Schiller agrees in a powerful proposal written in yesterday’s New York Times. A significant contribution to the current crisis, he writes, were the “countless fundamental mistakes made by millions of people who were caught up in the excitement of the real estate bubble, taking on debt they could ill afford.”

It is hardly surprising we have taken on more debt than we could ever hope to repay.  Yet Schiller’s reasoning is powerful in it’s simplicity - people do so because they don’t know any better.  Taking on a mortgage to buy a new home is like walking into the final exam of Calculus 101 … having never taken a calculus class.  Sure, you can probably figure out some of the problems, but you are not equipped with the right knowledge to succeed.

Schiller believes we should start “a major program to subsidize personal financial advice for everyone” with experts “to guide [us] through the … process, in a way that conveys patience and confidence that the problem can be solved.”  He continues:

This theory [of capitalism] assumes, however, that consumers are rational in their choices, and to a large extent they are. But in some areas, notably personal finance, it is important to recognize that a good share of Americans have difficulty figuring things out.

Most people get financial advice only from sales representatives of one sort or another: real estate agents, mortgage brokers, sellers of financial products. Some of these providers could use their sophistication to exploit people’s tendency to behave irrationally, and to manipulate the judgment errors that consumers typically make. And competitive pressures tend to make providers promote products that exploit those errors to the hilt, unless, of course, we offer consumers real financial advice…

Professional financial advice is now generally accessible only by the relatively wealthy. Changing this would be an important corrective step. Giving the general public access to trained advisers would be a boon for the nation in this time of doubt and distrust.

The key concept is this: we often don’t know what to do with our finances.  If we could arm ourselves with even basic knowledge of finance, our society would be significantly better off.  We would be less likely to spend more than we earn, buy houses we cannot afford, invest in risky securities.  This financial literacy is as much about a mindset as it is about facts and figures - we have to begin to think about our retirement, savings, access to credit, and housing differently.  

Schiller’s proposal of subsidized personal finance advisors is an excellent one.  It’s only a few hours till we have a new administration in the White House.  Let’s hope they are listening.