298. Everything You Always Wanted to Know About Money (But Were Afraid to Ask)

The bad news: roughly 70 percent of Americans are financially illiterate. The good news: all the important stuff can fit on one index card. Here's how to become your own financial superhero.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Stephen J. Dubner?

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• 0:48Stephen J. Dubner?

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• 1:21Stephen J. Dubner?

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• 2:11Stephen J. Dubner?

  Freakonomics Radio is sponsored by ChatGPT. ChatGPT Work is a new way to work in ChatGPT. ChatGPT Work can pull info from across your apps and connect to your tools to help you create finished work. You can even automate work in ChatGPT with the Scheduled Tasks feature, and the whole time, you stay in control. Put ChatGPT to work on your most ambitious ideas and projects. Get started at chatgpt.com by selecting Work Mode, available on Plus and Pro plans.

• 2:51Stephen J. Dubner?

  A bunch of years ago, I had just quit what I had thought was my dream career, trying to become a rock star. And now I was trying to figure out what came next. I was considering three options. Number one was to become a shrink. I really liked psychology, but in the end, I decided I was too selfish to spend my days helping other people with their problems. Number two was to become a financial advisor. I really liked learning about saving and budgeting and investing. But again, I was selfish. I didn't want to devote all my energy to other people's problems. Number three was to become a writer, and that's what I did. But the other ideas didn't just go away. There's at least a little bit of psychology in just about every episode of Freakonomics Radio.

• 3:34Stephen J. Dubner?

  As for the financial stuff, well, that's something we all wrestle with every day, isn't it? Today on Freakonomics Radio, we'll wrestle with it together. We will wrestle with the standard advice on how much to save.

• 3:48Speaker 01

  You have just told me to save 20% of my money. [BLEEP] you.

• 3:52Stephen J. Dubner?

  We'll wrestle with the fact that a financial windfall does not guarantee long-term success.

• 3:58Speaker 02

  We found that 15% declare bankruptcy.

• 4:03Stephen J. Dubner?

  And we'll lay out a personal finance roadmap that anyone can follow.

• 4:08Speaker 03

  Yeah, and it's basically, you know, pretty simple. Avoid emotions and concentrate on the economics.

• 4:35Speaker 04

  From WNYC Studios, this is Freakonomics Radio, the podcast that explores the hidden side of everything. Here's your host, Stephen Dubner.

• 4:55Stephen J. Dubner?

  Anna Maria Lusardi is an economist who teaches in the business school at George Washington University.

• 5:00Speaker 02

  I was born and raised in Milan and moved to the US about 25 years or so ago for my graduate studies.

• 5:09Stephen J. Dubner?

  As you can tell, she still sounds a bit Milanese.

• 5:12Speaker 02

  I have to say, I cannot get rid of it. It's inside me.

• 5:17Stephen J. Dubner?

  When Lusardi first moved to the States, many things were unfamiliar, our sports, for instance, especially American football.

• 5:24Speaker 02

  I only became interested in football because everybody is watching football on Sunday. So if I needed to talk to my friend, we had to talk about football first. And then, when I met the football players, then I had to be able to talk football seriously.

• 5:43Stephen J. Dubner?

  When she met the football players, what's that all about? Well, a few years back, George Washington University started a special MBA program called STAR that stands for Special Talent Access and Responsibility. The program was designed for people who were already very successful.

• 6:02Speaker 02

  They are often very wealthy and they have to manage many things, not just their wealth, but also their name, their reputations. And it just so happened that most of the students were actually athletes, and the majority of athletes were actually football players.

• 6:20Stephen J. Dubner?

  These were professional football players.

• 6:22Speaker 02

  Some of them were from the Baltimore Ravens, and I am a big Baltimore Ravens fan. They are, first of all, incredible students. They are my favorite students.

• 6:34Stephen J. Dubner?

  Why were they her favorites? Lucardi found her athlete students incredibly disciplined and perhaps not surprisingly good team players. She was also impressed with how charitable they were, and she was charmed by their sheer size. One day, she was talking about the financing options of buying a car. The example she'd always used in previous classes was a Toyota Corolla. But the football players all started giggling. One student raised his hand. "Professor Anna," he said, "I do not fit into a Toyota Corolla." Lucardi also realized that these NFL players were facing an unusual financial predicament.

• 7:13Speaker 02

  These are people which are very talented, very competent, but they have no knowledge of how to manage this money, where often they come from backgrounds where, you know, nobody has taught them financial literacy.

• 7:29Stephen J. Dubner?

  Financial literacy is, and has been for a couple decades, Anna Maria Lucardi's passion.

• 7:36Speaker 02

  You know, we make financial decisions every day. And the financial decisions that we make today are different than the decisions that our parents made. Our parents didn't have to worry about pensions, didn't face the type of mortgages we face now, didn't have probably all the credit cards and all this consumer credit at their fingertips. And also, they didn't have student loans. But we see other trends as well. For example, financial markets around the world have become more complex.

• 8:10Stephen J. Dubner?

  Many economists, for many years, have assumed that most people are financially literate.

• 8:16Speaker 02

  So, for example, we assume that people know about interest compounding, and they know about risk and risk diversification, and they act accordingly.

• 8:27Stephen J. Dubner?

  But how much do people really know about the most basic financial principles? That is what Lussardi, in collaboration with the economist Olivia Mitchell, set out to learn. They came up with three survey questions.

• 8:38Speaker 02

  This was actually driven by the fact that in the first survey, we only had room for three.

• 8:44Stephen J. Dubner?

  They piggybacked their financial literacy questions onto the 2004 Health and Retirement Study. Being limited to three questions turned out to be a blessing.

• 8:53Speaker 02

  Because, first of all, these questions are very predictive, but also because they are only three, they were adopted in so many national surveys in the US and then in as many as 15 other countries around the world. And more recently, a variation of these questions have been added to a global survey. So now we know about financial literacy around the world.

• 9:18Stephen J. Dubner?

  Okay, before we hear about the state of financial literacy around the world, let's hear the questions. Number one.

• 9:25Speaker 02

  Suppose you have $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow?

• 9:40Stephen J. Dubner?

  The answers were multiple choice. A, more than $102. B, exactly $102. C, less than $102. Or, if you really want to play along, D, I don't know.

• 9:52Speaker 02

  And the correct answer is?

• 9:54Stephen J. Dubner?

  The correct answer is A, more than $102. Because 2% interest on $100 in a year is $2. So after year one, you have $102. And then, over the remaining four years, the interest grows on that $102 and so on. And that is why compound interest has been called the eighth wonder of the world.

• 10:17Speaker 02

  Question one is about compound interest, but really is about assessing numeracy.

• 10:23Stephen J. Dubner?

  Okay, question number two.

• 10:24Speaker 02

  Question two is about inflation. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year.

• 10:37Speaker 02

  After one year, how much would you be able to buy with the money in this account?

• 10:43Stephen J. Dubner?

  The answers, A, more than today, B, exactly the same as today, C, less than today, or D, I don't know.

• 10:51Speaker 02

  The answer is less than today. Because if inflation is 2%, prices go up 2%, but if you have only earned 1% in your saving account, you basically can buy less.

• 11:06Stephen J. Dubner?

  And question number three.

• 11:07Speaker 02

  Question three has to do about risk diversification. Do you think the following statement is true or false? Buying a single company's stock usually provides a safer return than a stock mutual fund. True, false? And of course, you can say, do not know.

• 11:29Stephen J. Dubner?

  And the correct answer is true. Buying a single stock is safer than buying a mutual fund. Eh, just kidding. That's false.

• 11:38Speaker 02

  Because a single company is a lot riskier than a basket of stocks. Don't put all of your eggs in one basket.

• 11:48Stephen J. Dubner?

  Okay, how'd you do? Did you get all three right? If so, that would put you in a distinct minority.

• 11:56Speaker 02

  Americans are not financially literate.

• 12:01Stephen J. Dubner?

  That's right. Lucardi found that only around 30% of the respondents got all three questions right. The numbers are pretty similar around the world, even in other rich countries. In the US, financial literacy has some distinct demographic differences. Those facing most challenges, Lucardi and Mitchell wrote, are the young and the old, women, African Americans, Hispanics, the least educated, and those living in rural areas.

• 12:29Speaker 02

  So financial literacy should not be taken for granted. And actually, if you ask me, I think we are at a crisis level.

• 12:37Stephen J. Dubner?

  You might ask yourself, if financial literacy is so important and if so many people are so bad at it, what are we doing wrong? One simple answer is that even well-educated people often don't attain, as part of their formal education, much of a basic financial literacy. What about parents? Aren't they supposed to teach their kids the basics? Maybe, but money being what it is, a topic that makes a lot of people uncomfortable, you can see how a lot of parents, especially if they are not financially literate, somehow never get around to teaching their kids. Some people argue that financial education isn't the answer anyway.

• 13:19Stephen J. Dubner?

  They say the main problem is that too many financial instruments are either too complicated or inherently exploitive. We got into this debate in an earlier episode of Freakonomics Radio. Here's the legal scholar Lauren Willis on why it'd be better to design more user-friendly financial instruments than to expect everyone to learn more about personal finance.

• 13:42Speaker 05

  It's sort of like saying, well, we should start teaching everybody to be their own doctor, teaching everyone to be their own mechanic. Terribly inefficient to do that. Not only is it inefficient, but it has this sort of culture of blaming the consumer. You're the one who didn't figure this all out. You didn't go to the classes or didn't pay attention or whatever, and that's not going to help in the long run.

• 14:11Stephen J. Dubner?

  Anna Maria Lussardi does not share that view. At George Washington, she founded a research center called the Global Financial Literacy Excellence Center. Its mission is pretty obvious, and part of that mission, it turned out, was to teach financial literacy to a bunch of pro football players, whose circumstances, she points out, are quite atypical.

• 14:33Speaker 02

  They are very young, and they get all of the money that people earn in a lifetime early in life.

• 14:40Stephen J. Dubner?

  That's right. As Lussardi writes, "A career lasting six years, the median length, will provide an NFL player with more earnings than an average college graduate will get in an entire lifetime, plus a modest pension."

• 14:55Speaker 02

  But they just couldn't translate that sum of money, the lump sum they had, into the stream of money that could support themselves throughout life.

• 15:06Stephen J. Dubner?

  There are a lot of ways to blow a sudden fortune. Friends and family may come at you with their palms open. You're approached by all sorts of advisors with all sorts of brilliant investment schemes. There are taxes to pay, upper income bracket taxes, by the way, which shrink your net income by a lot. And of course, it's a lot more exciting to spend money today than to save it for tomorrow. Lusardi, inspired by her current football students, decided to gather some data on older players. She and her colleagues looked at a cohort of NFL players who'd been drafted in the late 1990s and early 2000s to assess their long-term financial outcomes.

• 15:48Speaker 02

  So we look at bankruptcy rather than other measure of financial distress because these are the things we can check in which there is data.

• 15:57Stephen J. Dubner?

  And what'd they find?

• 15:58Speaker 02

  We found that more or less 12-year into retirement, 15% declare bankruptcy.

• 16:07Stephen J. Dubner?

  That's right. 15% of these guys, who'd already earned a career's worth of income, went bankrupt, a rate that's similar or even higher than the overall population of men in their age group, even though the NFL retirees had obviously earned a lot more money. Lusardi also found that the risk didn't even decline for the players who earned the most.

• 16:27Speaker 02

  To me, the experience of the NFL is a good example of the effect of financial illiteracy.

• 16:36Stephen J. Dubner?

  The NFL bankruptcy data reinforced Lusardi's earlier findings about financial illiteracy. So what's to be done? Because it's pretty obvious that many people have no idea how to handle their personal finances, even people who you'd think should know, even exceedingly well-educated people like this guy.

• 16:57Speaker 01

  I must say, I had a very lackadaisical attitude about personal finance until I was about 40 years old.

• 17:03Stephen J. Dubner?

  That's Harold Pollack.

• 17:04Speaker 01

  I'm a professor of social service administration at the University of Chicago.

• 17:08Stephen J. Dubner?

  Pollak works with University of Chicago institutions like the Crime Lab and the Center for Health Administration Studies.

• 17:15Speaker 01

  I have a doctorate in public policy, but I hadn't really applied it to finance.

• 17:18Stephen J. Dubner?

  But then, something happened.

• 17:20Speaker 01

  My mother-in-law died suddenly, and my brother-in-law, Vincent, had to move into our home. He's intellectually disabled, and he was 340 pounds and had many related challenges.

• 17:32Stephen J. Dubner?

  Pollak's wife had to quit her job to take care of her brother. And Pollak began to worry about their financial health.

• 17:39Speaker 01

  I remember, one day, we had to buy a lazy boy-type chair, just because he was so big that our furniture didn't work for him. And it was like $900 for this chair. And I just remember thinking, like, I'm just gonna go through all my money. And I became obsessed with personal finance.

• 17:59Stephen J. Dubner?

  He began looking at the literature on investing.

• 18:01Speaker 01

  One of the first things I learned was that the conversation among real experts was actually a lot simpler than the conversation that you would get if you watched financial TV or read brochures from financial services firms.

• 18:15Stephen J. Dubner?

  The people Pollak calls "real experts," academics typically, who'd done real empirical studies, told a very different story than investment professionals.

• 18:24Speaker 01

  I started to joke around that the fundamental problem that the industry faced was that the best advice was available for free at the library.

• 18:33Stephen J. Dubner?

  Pollak started writing about these ideas on a blog called The Reality-Based Community. For one piece, he was interviewing the financial journalist Helene Olin about a book she'd written called Pound Foolish: Exposing the Dark Side of the Personal Finance Industry.

• 18:49Speaker 01

  And I said to her, you know, isn't the industry's fundamental problem that the best advice for most people would fit on an index card and it's available for free at the library? And we kind of chuckled, and the conversation moved on. Except that I started getting emails from people and comments on my blog saying, "Hey, where's the index card?"

• 19:06Stephen J. Dubner?

  But there was no index card.

• 19:08Speaker 01

  I was speaking metaphorically, so of course I was kind of stuck, but I had planted a flag and I felt I had to honor that. So I just reached into my kitchen drawer and I pulled out my daughter's four by six index card, you know, that she was using for school. And I scribbled down in, you know, maybe two minutes, nine rules, and I took a picture with my iPhone and I posted it on the web.

• 19:33Stephen J. Dubner?

  Coming up on Freakonomics Radio, Harold Pollak's index card catches fire on a variety of websites.

• 19:40Speaker 01

  Boing boing, which I'd never heard of, actually. Lifehacker, which I also had never heard of.

• 19:44Stephen J. Dubner?

  Also, are credit card rewards programs as good as they seem?

• 19:48Speaker 01

  All the research suggests that, that these reward programs just make you spend more money.

• 19:53Stephen J. Dubner?

  And how closely should you watch your investments?

• 19:57Speaker 01

  Don't peek!

• 20:07Stephen J. Dubner?

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• 20:52Stephen J. Dubner?

  Just head to granola.ai/freakonomics. That's granola.ai/freakonomics to get your time back. Try it for free at granola.ai/freakonomics.

• 21:10Stephen J. Dubner?

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• 21:53Stephen J. Dubner?

  Download the Quince app for app-exclusive offers or go to quince.com/freak. Get free shipping on your order and 365-day returns. Now available in Canada and the UK, too. That's Q-U-I-N-C-E.com/freak.

• 22:14Stephen J. Dubner?

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• 22:50Stephen J. Dubner?

  As I mentioned earlier, before settling into my writing career, I thought about becoming either a psychologist or a financial advisor. What I didn't mention is that the book I was working on before Freakonomics was a perfect hybrid of those two things. It was about the psychology of money. The working title was Money Makes Me Happy, Except When It Doesn't. That book got put in a drawer once Freakonomics started happening, but I still think its animating sentiment is pretty solid. Basically, money is one of those rare topics, a bit like sex, maybe religion.

• 23:27Stephen J. Dubner?

  That people have strong feelings about and yet have a hard time discussing. As a result, a lot of us stumble through life, knowing we should know more than we do about personal finance, but we're too intimidated, or embarrassed, or something to do much about it. Harold Pollack, a public policy scholar at the University of Chicago, tapped into this sentiment when he dashed off an index card with nine easy rules about personal finance. It got nearly half a million hits on Pollak's blog. The Washington Post picked it up. Also-

• 24:01Speaker 01

  Boing boing, which I'd never heard of, actually. Lifehacker, which I also had never heard of. A bunch of these websites that actually have big followings, that I'm too old to be in the target demographic for, really grabbed it.

• 24:14Stephen J. Dubner?

  The card was translated into Romanian.

• 24:16Speaker 01

  Which is great. I hope that people in Romania find it useful. I'm not sure that they have 401Ks there. I suspect that we'd have to modify it a little bit. It was, you know, just started showing up all over the place. In fact, there was a guy who plagiarized it. I found a YouTube video of some sort of a life coach who just wrote out his own card. It was word for word exactly what I wrote, and he spoke it as if he had made it up.

• 24:40Speaker 06

  And that's all the financial advice you're ever going to need written on this index card.

• 24:48Speaker 01

  It was hilarious to listen to, because he actually has a great voice, but he had completely stolen the idea. And there was just something about it for a lot of people where, you know, all of us are facing this very intimidating task. How do I save for retirement? Where do I invest my money? How do I deal with all these questions about budgeting and when to buy a house and all this kind of stuff? Oh, I just have to look at these nine rules on this card.

• 25:14Stephen J. Dubner?

  Pollak never pretended that he'd discovered some amazing new rules of financial behavior.

• 25:19Speaker 01

  When my colleagues at the business school saw this, and they saw what these rules were, they were just like, you're kidding.

• 25:25Stephen J. Dubner?

  But that didn't stop him from turning his index card into a book. Co-authored with the journalist Helene Olin, it is called, yes, The Index Card: Why Personal Finance Doesn't Have to Be Complicated.

• 25:38Speaker 01

  Of course, it's kind of ironic that I say, oh, you know, here's this index card. That's what you need. And then people are saying, well, why is there a book? And to me, it's a little bit like, you know, in some sense, you could say all of religion comes down to the 10 commandments, but a lot of us seem to need some commentary on those, need to know how to execute those, or depending on your religious faith, I sometimes refer to the book as the midrash to our index card for your Jewish listeners.

• 26:03Stephen J. Dubner?

  And for our non-Jewish listeners, a midrash is rabbinic commentary or teaching on a biblical text, not quite a canonical passage, but revered nonetheless. And that's kind of what Pollock was going for with the index card book. Okay, so what's in it? Let's start with rule number one.

• 26:24Speaker 01

  Rule number one, strive to save 10 to 20% of your income.

• 26:29Stephen J. Dubner?

  Because, well, if you're not saving any money, then everything else is a lot harder.

• 26:34Speaker 01

  One of the great things is, once you start to save this money, it really reduces the stress in your life so amazingly fast. I must say that my original card said you should save 20% of your income. And that's really hard. I got a bunch of emails that were essentially the following form. Dear Professor Pollock, I'm a 28-year-old, single mom, and I work as a cashier. You have just told me to save 20% of my money. [BLEEP] you. And my responses to all of those emails was, you know what? You're totally right. I totally see where you're coming from. At this stage in your life, you cannot save 20% of your gross income. And, you know, when you're at that stage, you know, how

• 27:19Speaker 01

  can you manage your credit card debt? How can you save something? How can you start getting yourself on a good budget? You're doing that, you're doing really well. So I think that my original card was really good for middle-class people like me. It wasn't quite as good for people that were at different stages in their life. And so I have to, I was brought to some humility by, you know, by the large audience that I inadvertently attracted.

• 27:44Stephen J. Dubner?

  Rule number two.

• 27:47Speaker 01

  Rule number two, pay your credit card balance in full every month.

• 27:52Stephen J. Dubner?

  How important is this one?

• 27:53Speaker 01

  You know, this may be the most important single rule on the card for a lot of people. If you're carrying a credit card balance, every dollar that you pay down on that, you're getting a risk-free, tax-free return that's usually more than 15%.

• 28:08Stephen J. Dubner?

  Because that's roughly how much you're paying the credit card company for the privilege of using their money.

• 28:13Speaker 01

  Unless your name is Warren Buffett, you're just not going to get that kind of investment from anything else that you're doing. And credit cards and other forms of high-interest loans are just a really serious trap for a lot of people.

• 28:27Stephen J. Dubner?

  One problem is that credit card companies are savvy, and they can make you feel like you're doing a great job just by paying off what they call the monthly minimum. You are doing a great job, for them, because they're collecting all that interest from you. Pollock warns us to beware of any deal that offers to help you smooth out your cash flow.

• 28:48Speaker 01

  So if you belong to a gym, and they say you can pay $500 upfront for the year, or you can make 12 equal $50 payments.

• 28:56Stephen J. Dubner?

  If you choose that payment plan, the cost of your membership is now $600. Therefore, whenever possible...

• 29:02Speaker 01

  You try to use cash as much as you can, and you pay off your credit card. And by the way, one of the things that I recommend to people is basically ignore your credit card reward program. All the research suggests that these reward programs just make you spend more money.

• 29:17Stephen J. Dubner?

  Rule number three?

• 29:20Speaker 01

  Rule number three, max out your 401K and other tax-advantaged savings accounts.

• 29:26Stephen J. Dubner?

  A typical 401K is a retirement plan run by your employer. But there are a lot of options, including for self-employed people.

• 29:34Speaker 01

  There are several reasons why your 401K or your equivalent is just the foundation of your saving.

• 29:41Speaker 01

  First of all, very often, your employer will kick in a matching contribution, and that is free money. You can also set up your 401(k) contributions to be automatic so you never have to touch the money.

• 29:53Stephen J. Dubner?

  There are other tax-advantaged savings vehicles.

• 29:55Speaker 01

  So, for example, there are two things that people can do to save money for their kids' college that have tremendous tax advantages. One is called an ESA, and I won't go into the details, but the second account is called a 529. And the 529 actually allows you, if you have a little bit more money, or you have a large family that wants to contribute, you can actually put in up to $14,000 a year.

• 30:20Stephen J. Dubner?

  Pollock works hard to not bring politics into his financial advice, but as soon as you get into tax-advantaged savings plans, you're getting into politics, because these tax breaks don't just happen. Someone in Washington had to draw up a plan that was meant to reward some kind of behavior, in the case of 401(k)s and 529s, that is saving for retirement and college, respectively. But the tax code is full of breaks, many of which, some people argue, tend to help well-off people become even better off. The home mortgage interest deduction, for instance. So what are you supposed to do if you think the tax code is unfair? Well, unless you've got some friends on the House Ways and Means

• 31:03Stephen J. Dubner?

  Committee, or the Senate Finance Committee, they're the people who write the tax code, maybe the best advice is to simply work hard to exploit the existing tax breaks. Sure, you can complain that the tax code favors rich people, or you could say, hey, using the tax code to my advantage could help me become rich. All right, moving on to...

• 31:27Speaker 01

  Rule number four: Never buy or sell individual stocks.

• 31:32Stephen J. Dubner?

  And?

• 31:33Speaker 01

  Rule number five: Buy inexpensive, well-diversified index mutual funds and exchange traded funds.

• 31:41Stephen J. Dubner?

  We actually spent our previous episode going over this idea in some detail. Bottom line: Most people who pick stocks for a living do a worse job than a monkey with a dartboard, and they charge you a lot more than a monkey would. How much? Enough to fund their beautiful offices and homes and boats, even though, again, your investment returns will likely be worse than if you just bought, as Harold Pollack notes, some low-cost diversified index funds.

• 32:14Speaker 01

  This is a completely easy one. There's just a ton of literature that suggests that people chase after shiny objects, and the stocks that we buy aren't particularly well-chosen, and the stocks that we sell, we're often selling them at the wrong times. So, you know, why do you want to get into that?

• 32:31Stephen J. Dubner?

  We also spoke last week with Jack Bogle, the founder of Vanguard, the world's largest universe of low-cost index funds. Here's how Bogle summarizes the appeal of what Pollock is preaching.

• 32:42Speaker 03

  You want to capitalize on the magic of compounding returns without succumbing to the tyranny of compounding costs.

• 32:49Stephen J. Dubner?

  But that tyranny of compounding costs can be hard to resist because the people who sell investment advice are really good at selling it. They make you believe that they alone know the secrets to the investing universe. They do it in TV commercials like this one. We understand the connections of a complex global economy. It's just one reason. Pollock's advice? Do not heed the siren call of slick, fancy, expensive investment advisors. For what it's worth, this has become quite standard advice, and it's backed up by acres of research. That research also suggests that for the average investor, diversification is a good idea.

• 33:30Stephen J. Dubner?

  A few different types of stock index funds: growth, value, international, et cetera, and also some bond funds and maybe some other less sexy investments.

• 33:40Speaker 01

  You want to have the right percentage of your investments in stocks and in the other classes that you invest in. So if the stock market drops 20%, you should be buying stocks after that, not because you think the market's now undervalued or anything like that, but just because the percentage of your portfolio that is in stocks is now below where you want it to be.

• 33:59Speaker 03

  I like the idea of a little balance in your asset allocation.

• 34:03Stephen J. Dubner?

  Jack Bogle again.

• 34:04Speaker 03

  For the youngest investors, and when you first start, obviously you should be 100% in stocks, but as you build up a little assets, maybe by the time you're 25 or 30, you're probably going to want to be 15%, 20% in bond funds and 85% in stock funds. And as you get older, you're going to probably want more in bond funds and less in stock funds. Because the fear of loss is going to be greater when you have a very large amount of money.

• 34:32Stephen J. Dubner?

  Obviously, it can be really hard for the average person to take in and execute all this investment advice on their own. So you might consider hiring a financial advisor, but, Pollock says, not just any financial advisor.

• 34:46Speaker 01

  Rule number six.

• 34:49Speaker 01

  Make your financial advisor commit to the fiduciary standard.

• 34:53Stephen J. Dubner?

  The fiduciary standard is a federal requirement designed to ensure that financial advisors don't sell clients products that are better for themselves than the clients.

• 35:03Speaker 01

  It basically says, all the advice that you're giving me and all the products that you're offering me are designed to maximize my own financial well-being. You're not being paid by anybody except me. I understand in a transparent way your financial incentives. And if you don't have the fiduciary standard, it's a little bit like walking onto the Ford lot and saying, do you think I need a new car yet? Or do you think I should keep driving the old one for another couple of years? There was a wonderful study done by some researchers at Harvard where they just sent out actors who had different kinds of retirement savings. And they would go into storefront financial firms and they would just say, hey, here's what we're doing. Tell us if we should do something different. And some of them had crazy investments that were, say, all in the stock in their employer.

• 35:48Speaker 01

  Some of them had absolutely excellent investments that have been designed by financial professionals in low-cost index funds and things like that. The ones that had excellent investments, the majority of the financial advisors they talked to recommended that they actually not do that, that they do something that is essentially a more expensive imitation of that.

• 36:12Stephen J. Dubner?

  This is not meant to besmirch the reputation of all financial advisors. It's also worth noting that sometimes it may be the advisors who try to keep their clients on the right track.

• 36:23Speaker 01

  So we get paid a percentage of assets.

• 36:27Stephen J. Dubner?

  Barry Ritholtz writes about investing but also runs an asset management firm.

• 36:32Speaker 07

  So the more assets we gather and the better those assets perform, the more revenue the firm sees.

• 36:40Stephen J. Dubner?

  Ritholtz has instituted a clever incentive to address his clients' investing behavior.

• 36:46Speaker 07

  If people maintain a portfolio for three years and don't do anything foolish with it, and there's a constant temptation to do something foolish, we will discount our fees an additional 15% as sort of a good reward for good behavior. The thinking is, left to their own devices, after three years, people get bored and they'll start, especially in a market like we've seen over the past few years, so they start looking for a little fun, a little action, and, hey, maybe we should roll out of this long-term conservative portfolio and start dabbling in IPOs and venture capital. And we want to discourage that behavior.

• 37:26Stephen J. Dubner?

  All right, moving on, to the single biggest expenditure most of us will ever think about.

• 37:32Speaker 07

  Rule number seven: Buy a home when you are financially ready.

• 37:36Stephen J. Dubner?

  Okay, so let's pull that apart. The buying a home piece and the financially ready piece.

• 37:42Speaker 07

  I think we should think of our home as something that we use and consume and something that helps us with our life, not as the major pillar of our wealth. I think that we've been conditioned from birth to believe that you're not a full adult until you own a home. And you have to be careful about that. You know, your home is the most leveraged and undiversified investment you're ever going to make in your life. And so you don't want to rush into buying a home. And you want to buy a home in a very sensible way.

• 38:14Stephen J. Dubner?

  Sensible meaning what?

• 38:15Speaker 07

  That means when you have a nice 20% down payment, which lets you get good terms on your loan, it means getting a sort of vanilla ice cream fixed-rate 15-year or 30-year loan, rather than to try to do something like an adjustable-rate mortgage.

• 38:31Speaker 01

  And it means buying a home that you can afford and still have a strategic reserve if you move in and your hot water heater breaks, or a raccoon eats its way through your roof, or all the things that can happen to a home.

• 38:43Stephen J. Dubner?

  Buying a home also represents what economists call a commitment device. It's a way to lock yourself into a behavior you need some help getting locked into. In this case, your mortgage payment is a forced savings plan. Pollock sees the value in this thinking, but the lock, he says, can be fairly flimsy.

• 39:03Speaker 01

  A home is a good commitment device, although it's a less effective commitment device than it once was because of home equity loans. Home equity loans used to be called second mortgages. There was a certain stigma to getting them. They were not common. And one of the challenges we discovered in the foreclosure crisis was there were just a lot of people that were trying to dip into their home equity. And when their value of their home dropped, boy, that could really blow up on you. So if you're going to use it as a commitment device, you have to actually commit to it and not try to dip into your home equity in various ways. So that's buy a home when you're financially ready.

• 39:39Stephen J. Dubner?

  Rule number eight?

• 39:42Speaker 01

  Rule number eight: insurance. Make sure you're protected.

• 39:45Stephen J. Dubner?

  Ah, insurance. So many types, so much pressure and fear. Honestly, that's a topic for a whole other episode someday. Maybe we'll get to that. But for now, here's Pollock's thumbnail take.

• 40:00Speaker 01

  The purpose of insurance is to make sure that you are protected if you have a life-changing event. You don't need insurance for the $500 problem when somebody hits a baseball through your kitchen window. You do need insurance when the tree falls and there's a $50,000 problem, you know, and your whole kitchen gets taken out. You need life insurance in case the people that depend on you need you after you die. You need liability insurance when you're driving. You need to make sure that your life wouldn't change if there was some sort of an adverse event. One of the things that we advise people in general is get the largest deductible that you can. You want the homeowner's insurance with the $5,000 deductible if you can get

• 40:42Speaker 01

  it. First of all, it costs money for the insurer to honor all these smaller claims. You really don't want to be having to pay for that. But secondly, the people who get the high deductible insurance are the people who know that they're pretty unlikely to use their insurance. So you're putting yourself in an insurance pool that's likely to be more favorable than the ones with the low deductibles. And so, so insurance is important to guard against the big things, not the little things.

• 41:10Stephen J. Dubner?

  Pollak's next rule, he admits, is in a different category than the others. It is not actually about personal finance.

• 41:18Speaker 01

  Rule number nine: Do what you can to support the social safety net.

• 41:23Stephen J. Dubner?

  Pollak has heard from a lot of people who don't like rule number nine.

• 41:26Speaker 01

  They said, you know, you're giving all this sensible investment advice, and then you got all political on me.

• 41:32Stephen J. Dubner?

  But Pollak thought it was essential to include this for a few reasons.

• 41:36Speaker 01

  One is, there's a lot of people who need help. Secondly, to the extent that my story is a part of our book, it would not be fully honest if I left off rule number nine. You know, at the beginning of our conversation, I talked about how my brother-in-law Vincent moved into our home and what a challenge that was because of his intellectual disability and his medical challenges. We would have absolutely gone bankrupt without his Social Security, Medicare, and Medicaid that prevented our family, you know, from losing everything taking care of him. And we have to have each other's backs. And what the social safety net does, what social insurance does, is it allows us to protect each other against

• 42:16Speaker 01

  these risks that would just crush any one of us if we had to face it alone. And I think it's really important, you know, as individuals, we should do everything that we can to be prudent investors and to support ourselves and our families and to follow the rules that I've laid out. But, you know, you cannot guard against everything in life. I don't particularly enjoy paying my taxes on April 15th, but I do feel that the American taxpayer had my back when I had a crisis, and, you know, I should be doing the same thing for other people.

• 42:47Stephen J. Dubner?

  As you may recall, Harold Pollack's index card had nine rules. But his and Helene Olin's book, called The Index Card, has 10.

• 42:57Speaker 01

  Rule number 10. Remember the index card.

• 43:01Stephen J. Dubner?

  OK, admittedly, this one is kind of meta.

• 43:04Speaker 01

  The idea here is, you know, we hope that this card is helpful. Take it out, put it on your refrigerator. It's a reminder.

• 43:13Stephen J. Dubner?

  A lot of recent social science research suggests that reminders like these, nudges like these, are pretty effective. Also, one reason people often fail to make good decisions, financial or otherwise, is because those decisions are too complicated or intimidating. So simplicity is a thing to strive for and to value. Will a simplified choice always lead to optimal outcomes? Of course not. But will it generally produce a better outcome than either avoiding the problem or doing something really stupid? Yes, it will. Experience is also pretty valuable, I guess it goes without saying.

• 43:58Stephen J. Dubner?

  So to conclude this primer on personal finance, maybe it makes sense to hear a bit more from the most experienced investor I know, Vanguard founder Jack Bogle.

• 44:12Speaker 03

  At almost 88 years old, you know, I might be the most blessed man in the United States of America.

• 44:18Stephen J. Dubner?

  Bogle's longevity was not preordained.

• 44:21Speaker 03

  In 1960, I had my first heart attack. I was only 30 years old, 31 years old. Had it on a tennis court. And I almost died. And I had a disease that had never been discovered. It was finally discovered years later in France. But I was a mystery man. And the doctors looked at me kind of funny. And when I got a pacemaker inserted, one doctor said to me, you know, you really probably don't have that much time left. So why don't you go up to the Cape and just, you know, walk out on the beaches every day? Take it easy, enjoy the remaining time on this earth.

• 45:02Stephen J. Dubner?

  Bogle did not follow that doctor's advice. A few decades later, he did need a heart transplant.

• 45:11Speaker 03

  The transplant took place 21 years ago. And I think I've broken a lot of records for anybody 65 years of age who gets a transplant. And not many 65-year-olds get 21 extra years.

• 45:22Stephen J. Dubner?

  So, let's hear your quick advice for a primer on personal finances. Aside from investing in index funds, we know you're going to advocate that. But it sounds like you've got a personal philosophy in terms of personal finance as well, yeah?

• 45:39Speaker 03

  Yeah, and it's basically, you know, pretty simple. Avoid emotions and concentrate on the economics. It's invest for the long term and don't trade. The ups and downs of the markets are unpredictable and foolish in the short term.

• 45:57Stephen J. Dubner?

  You say that as someone who's successful at avoiding emotions, but you have to know that most people aren't. Whether we're talking about investing or saving versus spending, or politics, or whatever, how did you either get to be the kind of rational thinker that you are? Or how do you advise people move in that direction? Because plainly, it's not so easy for most people.

• 46:19Speaker 03

  No, and let me be honest, it's not easy for me. And when we get one of these 50% declines, I've faced, I think, three of them in my career. It's not fun. I get a knot in my stomach. A lifetime of experience, 65 years of experience in this field, has taught me that emotions are evil, and therefore, you really ought to fight to keep them out of the equation. Because the day you're most concerned is the day the market hits bottom. And that's the day you want to get out. And the day you won't want to get in, when the market hits a new high. Well, believe me, buying in at the market's new high and selling out at the market's bottom is a very difficult way to make money.

• 46:58Stephen J. Dubner?

  What about spending versus saving? And how would you counsel someone to think about that?

• 47:07Speaker 03

  Every family is different, given the unequal distribution of income. 20% of the families can't possibly invest. They're trying to stay alive, you know, keep the wolf from the door, keep the children fed and housed and warm. So when you get up the scale of living, you're able to afford more. And I think people should pay themselves first out of every paycheck, have a contribution to a pension plan, and just keep putting it away. Don't even look at it. Don't peek. And when you open your envelope when you're age 65 and are retired, be sure and you have a good cardiologist with you, because you're going to faint.

• 47:49Speaker 03

  Faint with happiness, not with shock. Faint with happiness, right. You won't believe it.

• 48:03Stephen J. Dubner?

  Believe it. And if you still have questions about your personal finances, there's good news. Harold Pollack will be answering your questions during a one-hour Facebook Live event we're hosting on Wednesday, August 9th, at 2:00 PM Eastern Time. You can post your questions ahead of time on the Freakonomics Facebook page, or you can email them to [email protected] with the subject line "Personal Finance."

• 48:32Stephen J. Dubner?

  Freakonomics Radio is produced by WNYC Studios and Dubner Productions. This episode was produced by Greg Rosalsky. Our staff also includes Alison Hockenberry, Stephanie Tam, Merritt Jacob, Eliza Lambert, Emma Morgenstern, Harry Huggins, and Brian Gutierrez. We had help this week from Sam Behr. Most of the music in this episode was composed by Luis Guerra. You can subscribe to Freakonomics Radio on Apple Podcasts, Stitcher, or wherever you get your podcasts. You should also check out our archive at Freakonomics.com, where you can stream or download every episode we've ever made. You can also read the transcripts and find links to the underlying academic research. You can also find us on Twitter, Facebook, or via email at [email protected]. Thanks for listening.

• 49:30Stephen J. Dubner?

  Freakonomics Radio is sponsored by Ozempic. Innovation happens through rethinking what's possible. And when it comes to GLP-1s, Ozempic pill does just that. Learn more about Ozempic semaglutide tablets, 4 and 9mg, by calling 1-833-OZEMPIC or visit ozempic.com to view the medication guide and ask your doctor what's possible with FDA-approved Ozempic pill.

• 50:01Stephen J. Dubner?

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• 50:40Speaker 08

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• 51:40Speaker 09

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