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!
Advice To Spend Less And Save More
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.
Developing Prudent Spending Guidelines
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?