Pound Foolish

Journalist Helaine Olen has produced a strong criticism of the personal finance industry1.  She claims the industry does not add much value, makes unsubstantiated claims, charges huge fees, is fraught with conflicts of interest, and redirects attention away from its failures by preaching a false solution – financial literacy.  But aside from that, the industry is fine.

The fundamental problem is well known:  thanks to declining defined benefit pension plans and other factors, people increasingly have to take responsibility for managing their financial affairs, yet a large percentage of people are financially inexpert.  Financial products are complex (intentionally so, according to Olen), and are not easy to understand even by experts, and certainly not by the average person.

Meanwhile, a huge financial advisory industry has risen up to provide assistance.  Olen reports that as of the end of 2011, there were more than 300,000 financial advisory firms in the U.S.  Total advisory fees in 2011 were approximately $500 billion (about one percent of household financial assets).  Olen claims that customers did not receive commensurate value.  This is largely because advisors claim abilities they do not have (in particular, the ability to predict what will happen in the future with stocks, bonds or real estate). 

She singles out for specific criticism many of the more familiar personal financial “experts” like Susie Orman (keep a positive attitude toward money), Dave Ramsey (stay out of debt), Ron Kiyosaki (Rich Dad, Poor Dad), and CNBC’s Jim Cramer.  She notes that each of these people has developed a financial empire of their own, but has provided (she claims) dubious value to customers.  This is not really a new story.  One of the financial best sellers of the 1950’s was Fred Schwed’s classic “Where are the Customers’ Yachts?”

In contrast to many authors, Olen does not believe financial literacy programs provide the answer.  She asserts that there is no evidence of superior decision making by individuals even after twenty years of financial literacy programs.  Other “solutions” are equally disparaged, like the notion that you can become a millionaire by foregoing the daily Starbucks latte.  Olen shows that the assumptions lying behind this calculation are extreme.  She refutes the “Millionaire Next Door” story in which frugality and entrepreneurship lead to financial success by pointing out that most entrepreneurial efforts fail and most sole proprietors are people who have been laid off from their regular job.

The bottom line to Olen is that the obstacles to financial affluence and independence for most people are overwhelming and out of their control.  These obstacles include:  falling real wages for the middle class, declining mobility, rising inequality of income, and a weakening safety net.  Thus, she boldly claims:  “we do not live in an economic environment that will permit mass personal financial prosperity.”

While I follow Olen’s argument on many points, including high fees and commissions, widespread conflicts of interest, and financial product complexity, I was surprised by her conclusion that widespread financial prosperity is not feasible in this country.  This is because we already have it!  The average household real consumption is more than 20 times what it was 200 years ago and 7 times what it was 100 years ago.  By any reasonable historical standard, the median income household in America today is rich, and even the poverty line household is doing better than the vast majority of people that have lived before.

But what about Olen’s claim that real wages have been falling for 30 years?  In fact, data from the BLS show that the median real wage (using the consumer price index as the deflator) has been flat since the mid 1960s.  However, total compensation includes wages and benefits, and the benefit share has been rising steadily.  Yes, health care costs are rising, but so in the quality of health care.  Yes, the cost of housing is rising, but so is the size and amenities of the average house.  Yes, the cost of higher education is rising but so is the return on investment in education.  This does not mean it is easy for the average person, or even the higher income person, to save a high proportion of their income.  But it is not impossible.  Like gases in a closed container, spending tends to expand to fill available income.  The trick is to automate savings, so that consumption expands to exhaust income net of desired saving.

 There is, I believe, substantial opportunity for nearly everyone to improve their financial position.  The first step is build savings.  The second is to avoid paying the giant fees that are charged on some financial products, while maintaining product quality.  For example, broad based passively managed equity funds provide the retail investor equity-like returns at very modest fees (typically about .1% per year).  While there are very complex versions of every financial product, there are simple versions as well.  Following Olen, it is important to realize that much of the financial advice you run across may be influenced by the size of potential commissions.  You need to find a source of good advice that is not biased.   

 1Helaine Olen, Pound Foolish, Wiley, 2012.

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