A friend of mine works in the finance industry and teaches a financial literacy course for the church that he attends. I decided to attend the class with my wife. I went partly because I just enjoy listening and talking about personal finance (surprise surprise!), but also because I wanted my wife to go to the class. Unlike me, she isn’t all that interested in personal finance topics. She only reads my riveting personal finance posts when I ask her too!
One of the topics taught at the class was about paying down debt, and my friend advocated Dave Ramsey’s “snowball” method. Basically with this approach, you pay the account with the lowest balance first and then move on to the next one. At the end of the class, I talked to my friend and said that I did not agree with the snowball method. I said that the math doesn’t make sense and that you should pay the account with the highest interest rate first to save on the interest you pay. My friend told me that while math may be on my side, his experience told him that paying off small balances motivated people to continue on the path to debt freedom.
After this conversation, I came to the realization that math and logic does not always work in personal finance. Of course personal finance is personal and it depends on the person. For better or worse, I think of myself as someone who bases most of my decisions on logic. While I might think I base my decisions on logic, nobody is a robot. As human beings, we have complex emotions and we use both reason and feelings in our thought process when we make decisions.
Laurie The Frugal Farmer said,
“What matters most about a debt payoff plan is whether or not it will allow you to stick with it through to the end”
We need to be motivated. We need to be inspired. We need that so we stay disciplined and committed to our financial goals. That’s why there are so many personal finance articles teaching you to trick yourself to save more money or to trick yourself to spend less money.
One thing that I never really understood was the concept of “forced savings.” I’ve always been a saver and never felt the need to be forced into doing it, but for some people, they may need it.
Buying a house
I know a high-earning couple who accumulated a good amount of debt, including both student loans and consumer loans. They can’t seem to save much, yet decided to buy a house recently. One of the reasons cited was that it would force them to save. I think that for people who are not ready financially to buy a house, it is often better to rent and save up a down payment as well as fix up your finances before buying. Renting is usually cheaper than buying, and you can use the savings to help fund a down payment. That sounds good in theory, but do most renters really save the difference?
Megan McArdle from Bloomberg View said,
“[P]ersonal finance really isn’t about math; it’s about discipline. And homeownership, whatever its drawbacks, does force people to save, even if the rate of return on those savings is low.”
Buying whole life insurance
I’m not a big fan of buying whole life insurance. I’m in the camp that believes the mantra “Buy term and invest the rest.” I think that you’d be financially better off doing that. Once again, the same high-earning couple I know were looking into life insurance, and they chose whole life insurance. When they told me the arguments for buying it which they parroted from the
insurance agent financial advisor, I just shook my head (figuratively). Specifically, they touted the investment portion of whole life insurance. While I think there is a place for life insurance in estate planning and certain tax circumstances, I don’t think it’s the right financial choice for most people because of the higher premiums, fees and lack of transparency. But maybe I’m wrong? While I might buy term and invest the rest, is someone who needs to be “forced” into saving really going to do that?
Large Tax Refund
Not to pick on this high-earning couple, but another method they use to force themselves to save is to claim “0” exemptions on their W-4. One reason is because they are deathly afraid of owing taxes. This really shouldn’t be a fear because they get a substantial tax refund each year. The other reason is because they like getting a big refund. Someone who is financially savvy would not like this method to save money because you’re basically giving the IRS an interest free loan for the year. The better method would be to claim the proper amount of exemptions and automate your savings throughout the year. But once again, are those who are bad at saving really going to save or would they be better off keeping their spendy hands off of the money? Honestly, I have to admit that while I know that a small tax refund means I did a good job putting money in my pocket throughout the year, I really like getting a big refund! Argh! I think my emotions are getting the best of me!
Now I’m not advocating for people to buy a house when they’re not ready, to buy whole life insurance rather than term life insurance, or to claim “0” exemptions. I just don’t want to be someone who thinks that there is only one right way to do things when it comes to personal finance. What works for me, might not work for others. I can get on my soap box and argue why my method of saving is better mathematically until I’m blue in the face, but if others aren’t inspired or motivated to follow, what good is it?
Do you lean more towards emotion or logic when making financial decisions? Do you have to trick or force yourself to save money?