As a country, our national savings rate is among the lowest in the world, and in practice the average American struggles to save much of anything. A recent survey by the National Foundation for Credit Counseling indicated that 64% of Americans don't even have enough cash on hand to handle a $1,000 emergency expense. The standard advice of financial health to address these problems is to "Spend Less, and Save More" or its extended version, "Spend Less Than You Make, And Save The Rest." Yet notwithstanding the nearly universal nature of this advice, it doesn't seem to be having much of an impact. Perhaps the problem is because in reality, the advice just isn't specific enough to be actionable, and as a result it's ineffective. In other words, if we really want people to spend less and have more money left at the end of the month, what we need to do is not just tell people to "Spend Less, and Save More" - we actually need to tell them HOW to spend! We need to create the "food pyramid" of recommended spending!
Monday, December 5. 2011
The inspiration for today's blog post comes from some recent brainstorming I was doing about the parallels between good advice for financial health and good advice for physical health, extending from last year's FPA Retreat session by Karen Miller-Kovach, the Chief Scientific Officer from Weight Watchers who shared some of the research used to help people form better weight loss habits. After all, there are some striking parallels - with financial health, it's "Spend Less and Save More" while with physical health it's "Eat Less and Exercise More."
Yet there's a notable difference. The weight loss world has long since realized that "Eat Less and Exercise More" is actually rather ineffective advice. People don't know how to act on it. How much exercise is enough? Walking up 2 flights of stairs everyday? Taking a 10 minute walk? Getting on the exercise bike for 20 minutes twice per week? More? Less? Similarly, what does "eat less" really mean? If I just regularly order the medium fries instead of the super-size fries at McDonald's, is that enough? If I cut out the appetizer salad and just eat the steak entree I'm "eating less" but probably not advancing my cause.
Instead, effective advice for improving physical health needs to be more specific. It's not just "exercise more" - it's exercise for at least 30 minutes, 3 days per week for maintenance, or at least 50 minutes, 5 days a week for weight loss, and get your heart rate up to 50% to 75% of your maximum heart rate (which is approximately 220 minus your age, according to the American Heart Association). And it's not just "eat less" - it's eat up to 2,000 (for women) or 2,500 (for men) calories per day, and cut your intake by 1,750 calories per week to lose 2 pounds per month. And perhaps more importantly, it's not really about just eating less, it's also about eating healthy - for instance, by following the recommended food pyramid (now the recommended food plate from ChooseMyPlate.gov) for a balanced diet.
When we look to the advice on financial health, though, we seem to lag behind. We criticize people for not saving more, yet do a poor job providing them advice about how to come up with the money to save. We criticize people for spending more than they make and not living within their means, yet we give virtually no advice about what a balanced household budget (like a balanced household diet) should be in the first place. And that's the problem.
So what's the solution? Simply put, we need to tell people how they should spend. We need to give them the recommended financial pie of household spending, with suggested allocations of how much to spend in the various categories of food, rent, transportation, and other categories, such as this graphic from the Department of Labor (although this DoL graphic is descriptive of what people currently do, not prescriptive about what they should do). As I've noted before, planners should play a more active role in setting appropriate spending policies and guidelines for clients, although this isn't just about the planner-client relationship; a balanced spending pie for financial health is an educational tool that could be developed by the profession (e.g., through the CFP Board, or by FPA or NAPFA) to educate the public at large.
Now I know what many of you are probably thinking... every client's circumstances are special and unique, and it's up to them to make a decision about whether they want to accept the trade-offs between spending more now, or spending less and saving more. To which I can only politely respond: bull$#!^. If there's one thing we've learned from the emerging field of behavioral finance, it's that people often make irresponsible, irrational decisions, if we don't provide some helpful guideposts. It should not be the mission of our profession to just accept that people taking self-destructive actions are choosing to do so.
No, that doesn't necessarily mean we're going to dictate to clients that they must spend exactly 35.00% of their income on housing and 15.00% on transportation, and no more or less. But the behavioral research is clear that anchoring matters. Just as every client's body is different, and not every male needs precisely 2,500 calories to maintain body weight, it's still clear that eating 5,000 calories is a poor, self-destructive decision in all but the most exceptional of circumstances. Similarly, telling clients to spend 15% on transportation makes it pretty darn clear that when you earn $4,000/month, spending $1,200/month on a car payment - a whopping 30% of income, before accounting for gasoline and other car maintenance - is going to be a pretty bad idea. In other words, it's not about entirely removing flexibility from the recommendation; it's about anchoring people to reasonable expectations in the first place, so that at least when they do deviate from the recommendation, they're deviating from a reasonable starting point and by a (hopefully) reasonable amount!
So the bottom line is that while we like to think of every client as being their own unique special snowflake, the fact remains that there is still a certain relationship between income and a reasonable distribution of expenses, just as there is a relationship between a person's body and reasonable eating and exercise habits. Yes, there may be individual variations, and each person may adjust a standard rule of thumb for his/her own individual needs, but nonetheless, providing specific, actionable spending guidelines still ensures that clients are anchored to the right starting point in the first place. It also ensures that they look at all slices of the pie, instead of the all-too-common situation where individuals overwhelm themselves with car and rent/mortgage payments, and then go nuts trying to trim spending from the small stuff because they didn't have appropriate guidelines about what was reasonable for the big stuff.
So what do you think? Should financial planners play a role in establishing standardized guidance on prudent spending patterns? Should we help create the recommended spending pie, so that people can anchor their spending to reasonable expectations - and so that at least if/when they do vary their spending based on their individual needs and circumstances, they're varying from an appropriate starting point? If the recommended spending pie included a slice for savings, could we really help people become better savers, if we actually give them guidance on how to appropriately spend the rest of the pie in the first place?
For most, the question of "minimums" in financial planning is a practice management issue from the firm's perspective: how much in fees must a client generate to be economically feasible, based on the firm's particular service model? Yet as fina
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Google "Health and wealth connections: implications for financial planners by Barbara O'Neil"
Guidelines are easier with health than wealth because of smaller variances. It is rare to find someone who weight times the average. The distribution of income and assets has wide disparity. Health goals are also uniform, while wealth goals have huge diversity. Not to mention regional differences (housing, heating cost, etc.) So, individual circumstances and goals will lead to spending targets with too much diversity to make a standard financial diet applicable--unless it's applied to a specific (somewhat homogeneous) group. In my opinion, that's why we talk of public health, but personal finance.
More at the AICPA PFP conference. See you there.
Kevin, I thought I'd chime in on the fee part of this work. That's all I do; fee only planning, ciaching and advice. I don't offer or sell any products. The budget/spending/debt planning work I do is on a sliding scale for those at least trying to accomplish some good in their financial lives.
I will say, however, that most of my clients do not need this kind of help (the majority of them come to me for comprehensive planning) but I wanted to at least make it available to those who do.
I'm thinking of starting a support group for financial wellness resolutions.
I have long thought that a financial "diet" could benefit from a similar approach. Not only what you're suggesting, Michael (being taught a baseline of healthy habits), but also participating in a community of people with the same goals and same struggles, people who could commiserate with and learn from one another.
I think we all tend to suffer from the "Facebook effect," where we think everyone else's lives are so much better than our own because people post only that which makes them look good. By contrast, in a WW-weekly-meeting world, being privy to the fact that others struggle (and succeed) just as much as you do might minimize the frustrations, embarrassment, and sense of futility that we/our clients fall victim to in our efforts to improve our financial lives.
Great post. There are two main issues I would like to mention.
I agree that we should be anchoring people with good defaults that they can then deviate from. Studies on 401K enrollment show how useful having good defaults can be towards encouraging the right behavior.
But knowledge is not enough. You also need the structural support to make following those defaults easier. For example, what if when you set up your direct deposit, The money automatically got divided into its constituent parts (e.g., savings for retirement, savings for car, rent/mortgage, utilities, etc). And of course, people could change from the defaults. The person would then always have immediate feedback on how they were doing and would be much more likely to follow their spending plan.
There is an arms war between producers and consumers where producers use every psychological trick in the book to increase sales of their products regardless of how detrimental that might be to society as a whole.
Although the weight loss industry may be ahead of the planning industry, obesity in the US is still increasing, so the current techniques are still losing the war. And I am not sure the war is winnable until a company like McDonalds has an incentive to say something besides "do you want fries with that" to the 300lb diabetic.
I have no idea how to solve this problem however.
Last week retailers had record sales! How can that happen when the economy and personal incomes are tanking.People are not stupid, but are driven to satisfy wants.
I know a lot of very intelligent people who smoke and/or are obese or overweight. They are good people who make bad choices and they don't appreciate anyone making them feel guilty.They know the information, but choose to not change their behavior.
Many restuarants have tried putting the calories, carbs, and grams of fat and sodium on their menus. In general, people don't change their behavior and the restaraunts eventually drop the info.McDonald's is more popular than ever.
I believe people who save have a fear of not having money and this fear drives them to delay gratification. With many couples, there is a saver and a spender. This dynamic is usually not changed by data, charts, Monte Carlo anlalysis,etc. Unless advisors want to instill fear(I go as far as a Monte Carlo anlaysis to show the consequences of not saving enough or spending too much), I think delving into the nitty gritty of enforcing budgets may work for awhile, but will fade over time and create a negaive advisor-client dynamic.
The number one month for health club memberships is January--after over eating at Christmas and pledging new resolutions. By February and March, a substantial percentage of the new members will drop out.
Behavior is hard to change and very time consuming to try to change.
I think an advisor's time is better spent working with clients who understand savings and are disciplined to take advice, rather than telling them that staying at the Bellagio is not appropriate for someone in their financial situation.
The social support IS powerful -- I joined with a couple of friends and my sister and we did a "biggest loser" challenge. I was surprised at how effective a little competition and comraderie were. I am currently trying to figure out a way to replicate this with clients. Short of establishing a new service model that includes group meetings, I haven't come up with a good substitute -- anyone have suggestions? The weight watchers model of having everyone pay for each meeting attended (or monthly CC charge for meetings and online tools) would work quite well if you could get enough volume...
My belief is that having a powerful internal goal is key for both weight loss and spending control, especially if the social support isn't available. You/your client, is not going to change their behaviour until they get a handle on their motivation.
People DO what they WANT to do. Until Madison Ave, or wherever, starts convincing people it's cache to save and invest instead of have a new Beemer, I don't think WE will have much luck converting the masses. (Think: I didn't know how much I needed "one of those" until I saw it on TV.)
And for the middle class who need this most? Well, I'm not so sure it's even up to them when you look at what it costs to raise a couple kids, buy health insurance, and pay your taxes.
All of the issues you raised (anchoring, behavioral biases, irrationality) have all been addressed as well as appropriate and beneficial tools, depending on each person's particular style. As my friend Nancy Rizzo (a life coach) says, "Is it simple, comfortable, doable and your way?" (because if it isn't you won't keep it up).
I don't know if or how any of this work will translate into income for me but I kind of look at it as a ministry.
and to think long-term. In the end it boils down
to what kind of a person are you: long-term or Short term. If you are a short term person, no advice will be helpful.