Why So Much Financial Advice Is Useless
With many middle- and low-income workers lacking access to mortgages, IRAs, or even savings accounts, the saving mantra beloved by advisers is wrongheaded and sometimes harmful.
Janice, a middle-aged card dealer living in Mississippi, has both a checking account and a savings account. But she cut up her checkbook, using cash and money orders to pay bills instead. She chose a credit union whose closest branch is an hour and a half drive away for her savings account. She cut up the ATM card as soon as she got it too.
Mike, a building manager in Ohio, only rarely spends more than $20 at a time. It happened just six times during the year we got to know him. He buys groceries and gas every few days, always in cash, even though he has a bank account. He saves in cash too, keeping $100 in his wallet and more than that stashed in two separate envelopes at home—one for his property taxes and one as a general fund.
These choices may seem unusual, or worse—wasteful and foolish. Why waste time and gas money driving to the bank? Why shop so often when buying in bulk could be cheaper? Why risk theft and pay fees to buy money orders instead of keeping money safely in the bank and using checks to pay bills? Janice and Mike’s financial management strategies don’t just fly in the face of typical financial advice—they give it a knock on the chin. And certainly their choices don’t fit with how banks expect customers to use their products. But workarounds like these are not only common, they also usually have a well-reasoned explanation.
Janice cut up her checks to avoid the temptation of payday lending. Janice is a card dealer, and the size of her paycheck depends on tips, which are higher in the summer, or when football games are played near the casino where she works. The volatility of her income means that she sometimes needs a way to access cash when she doesn’t have it, but will in a few weeks or next month. In her words, she “got into trouble” with those high-priced, two-week loans in the past. Payday lenders require a post-dated check to make a loan, so Janice cut up her checkbook. She parked her savings in a faraway bank as another way to create discipline.
Mike spends in cash and in small amounts to maintain clarity and control. Like Janice, he doesn’t have much cushion between what he earns and what he spends—both have annual incomes above the poverty line, but not much. Also like Janice, he has ups and downs in his earnings, though in his case, those stem from when he works overtime. He works overtime often, and the extra income is crucial to paying his bills. But, he never knows exactly how much overtime he will get, or how quickly his boss will pay him for it. Knowing his exact balance and spending in small amounts is important for him to keep his spending within his budget.
Mike and Janice may be idiosyncratic, but they are not unusual. They are two of the people we got to know through the U.S. Financial Diaries project. Our research team tracked every dollar that came in or out of the homes of 235 households for a full year. All the households we talked to had at least one worker, and none were among the poorest or richest in their communities. Beyond that, the households were diverse: rural, urban, white, black, Hispanic, Asian, recent immigrants, and families in the U.S. for generations. The data about how families earn, spend, save, borrow, and plan creates a moving picture of their strategies to create economic security out of lives that were often inherently volatile.
The data suggest that predominant personal finance messages are incomplete—and sometimes flat wrong. Take savings guidelines, for example. It’s standard to advise that people should set aside big chunks of money for emergencies. Some experts suggest saving three months’ worth of income, while Suze Orman ambitiously suggests eight months. It’s common to urge automating saving too, so that money moves regularly from a paycheck or checking account into savings. It is a given that financial literacy curricula urge people to forgo spending now and instead focus their attention on long-term savings goals, especially home ownership, education, and retirement.
These are good ideas for lots of people. But this advice is not the right advice for many financially struggling families. In our research, we found that (on average) workers earned their “average monthly income” in only seven months out of the year. In the other five months of the year, they earned at least 25 percent more or 25 percent less than that. This is a result of tectonic shifts in how work functions, as more workers share in the economic ups and downs of their employers. We found that spending was just as volatile. Combine this volatility with the fact that incomes have remained stagnant over the last several decades while the cost of living—especially the costs of housing, health care, and education—has been rising, and it’s easy to see why so many working families simply don’t have the space between their earning and spending needs to set aside big chunks of savings.
It is also easy to see why so many people shy away from automating anything in their financial lives. They prefer to know exactly which bills are being paid when, and how much cash will be left for whatever is around the corner. The cornerstone of advice on saving—and most other personal finance advice—is budgeting with a long-term vision. But it’s hard to plan for retirement a few decades from now when the next few months are so unpredictable.
Given that, exhortations to save more for the long-term mean little if families don’t have workable tools to manage pressing near-terms ups and downs. Families are not putting a priority on weighing how to diversify their retirement portfolio, or choosing what mortgage terms are best. Instead, they are more often putting their energy toward thinking about immediate financial questions, like whether to use their tax refund to pay down debt or fix their unreliable car. Janice and Mike’s workarounds point the way toward some useful new ways to think about financial advice.
What to do? First, figure out how to balance discipline and flexibility in a way that works. It’s helpful to create real barriers to spending versus saving, but those barriers have to be sufficiently porous that you can get the money if you need it, rather than ever more inflexible as many suggest when they see money coming out of retirement or college savings accounts. Janice chose the hour and a half drive to make a withdrawal from her savings because she knew she would only do it for “really, really needs.” But she can still do it when those “really, really needs,” like back-to-school supplies for her granddaughter, arise. If it was even harder to get the money, Janice might avoid saving at all. But if it were easier, saving would become impossible.
Second, make saving a treasured behavior, not a treasured amount. The whole reason to save is to be able to spend when you need to spend—not to keep a certain amount of money set aside at all costs. The idea is to make savings itself a habit, and to allow the amount being saved to fluctuate up and down with available cash. More attention should go to helping people know when and how to spend their savings, with recognition that a big part of saving involves building up balances, withdrawing money as needed, and building up again. Saving is best thought of as an activity with inflows and outflows, not a steady accumulation toward a given balance.
The key to effective financial advice is to help people to achieve multiple complicated goals simultaneously. Families have to weigh the often conflicting needs of spending now, planning for later, and saving for needs arising soon. We all need structures, but we also need flexibility within those structures. Financial advice must change if it is going to help more people to achieve security amidst volatility.
Jonathan Morduch and Rachel Schneider are the authors of The Financial Diaries: How American Families Cope in a World of Uncertainty (Princeton University Press). Morduch is a professor of public policy and economics at the Wagner Graduate School of Public Service at New York University, as well as a founder and executive director of the NYU Financial Access Initiative. Schneider is senior vice president at the Center for Financial Services Innovation, an organization dedicated to improving the financial health of Americans.