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Do we get a lot on personal finance wrong?


An interesting article appeared in The Straits Times on 14 January 2023. Written by Tim Harford, the title was a deliberate click bait “We get a lot on personal finance wrong”.


A screenshot of Tim Harford's article on 14 January 2023.



The key point raised by Harford was that theory and practice are oftentimes not on the same page. A quote attributed to Albert Einstein was that “in theory, theory and practice are the same. In practice, they are not”. But before we decide to cast theory into the trash can, it is important to note that theory can be key in helping us make important decisions. Theory guides us until it doesn’t. Immanuel Kant describes the relationship between theory and practice as “theory without practice is empty, practice without theory is blind”.


So is Harford right in saying that we do get a lot on personal finance wrong because theory and practice are often not in sync? Also, if that’s the case, how can we start getting personal finance ‘right’? I’m going to break down some critical lessons from Harford’s article and how we can then get it ‘right’ in our lives.



Theory: Equities are less risky the longer you hold them.

Practice: Not always true.


Over a longer time, markets will fluctuate, and downsides can be offset by upside, and equities tend to outperform. This is true over a long period of time or strictly speaking, in an infinite time horizon.


However, we don’t live forever, and the longer and more we hold equities, the more likely such assets will take a hit. In theory, if we can hold the asset class longer, it has a good chance of recovering. But how long can we hold these equities? Amazon is a success story that we know today; but in 1997 when it first got listed, share prices hovered between a couple of cents to about $4 for over a decade. Conversely, Nokia was a raging success back in the day, and now it is struggling. Will it recover? No one knows.


How to get personal finance ‘right’ as much as possible: Diversification protects returns. Sacrifice the urge to want to earn maximum returns, and recognise that bonds, endowment, and fixed deposits all have a role to play in your portfolio. While theory averages out the effects over time, practice is when you are living in the moment and effects don’t get averaged. Furthermore, most of us engage in investments over time, in that we either use Dollar Cost Averaging or top-ups when our pockets have some extra money. This means that over time, more and more of our money is exposed to risk, and the additional funds we put in are actually on a shorter time span.



Theory: Pay off your highest-interest debt first

Practice: Not always advisable. Sometimes you should pay off the smallest debts first, even if it has a low-interest rate.


This is a classic case of human behavior affecting theory. Paying off the highest interest debts is the most logical approach, mathematically. But this requires individuals to be laser-focused on debt repayment, over some time. And we do get disappointed, especially if the debt is large, and it does not appear to reduce much over time. As a result, we lose motivation and stop paying off the debt. By paying off the smallest debts first, you get a taste of success which can encourage you to continue, and you now have more money to put towards the larger debts, which will have a bigger effect. This ‘snowball’ effect motivates us to do more.


(Caveat: do pay off the minimums of ALL the debts first; you don’t want the larger debts to grow due to late payment fees.)



How to get personal finance ‘right’: This is more for those who are struggling to pay multiple debts, with different interest rates and different amounts. If you have many debts and the size of the debts differ significantly, and you struggle to consistently pay them off, then consider this approach. Alternatively, sign up for GIRO payments so that you don’t risk forgetting to pay the debt on time.


Theory: We can plan, and the plan will work.

Practice: Life happens.


We like to think we can consider what are all the possible outcomes in our life that we can plan for. But most situations in life involve uncertainty for which historical data provides no useful guidance. For data to be helpful, it needs to be accurate, complete, timely, and valid. In most cases, we won’t have all of these facts. Furthermore, data is often aggregated; while a system may have a probability table, individuals work with binomial probability: either it happens or it doesn’t. As such, thinking for an individual is different from thinking as a group.


The idea of planning is to efficiently and deliberately allocate resources towards known plans and to maximize the remaining resources. But you would need to know what the possible risks are in order to plan for them, or even to know what exactly you want to do. Because life happens, unexpected things can happen and our goals change. We think we know what we want, but as E.M. Forset says, “How do I know what I think until I see what I say”. Sometimes, we don’t know what we want until we see it. And money gets pulled into different purposes.



How to get personal finance ‘right’: Set money aside for “that unknown”. Over-save for specified goals (e.g. retirement, holidays). If you end up with more money than you need, you’ll never regret it but the converse can hurt you badly. On top of that, the more you save, the less you spend, the easier it is to live within your means. I like to say that either you “have so much you cannot outspend or spend so little you won’t lack”. If you need to balance, err on the side of caution and always save more. When disaster strikes, we need to first survive them first.


With this, I hope we can get personal finance ‘right’ more often than not.


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