In Search of a Financial Theory of Everything

This article is the first from new staff writer El Nerdo.

First things first (and I try to be organized that way): I think my first “official” post for GRS should be a sort of statement of purpose, an outline of what I’ll be trying to accomplish here, as a kind of introduction of things to come.

It makes sense as part of the job interview process that I should answer such classic questions as: “What can you bring to our organization?” Or, “Where do you see yourself five years from now?” I really believe that GRS readers got me this job, and I feel I owe you those explanations, even after having been hired. Please don’t be afraid, I’m not going to ramble about myself until your phone suddenly wakes you up a half-hour later. I’m actually trying to write something useful.

Let’s start by making something clear: I’m not here to dance for the money. I’m here on a mission! Almost like the Blues Brothers. The way I see it, I’m getting paid to research and to learn about something that interests me. And as I discover and learn new things, I will do my best to share these things with you.

However, it has to be said, I learn a lot from you, and everyone here could school me on a huge number of subjects. In fact, I have learned more from you than from reading a bunch of books. So, how can I avoid becoming an echo chamber that simply regurgitates your ideas?

I have a plan for that, and I’m asking for your help. But first, a little background information so you understand where I’m coming from.

The Cause
I’ve been broke for most of my adult existence, and I’ve only started to dig myself out of the hole in the past two or three years by applying some basic principles that are easy to follow. Let me emphasize this: simple and easy to follow, such as “spend less than you earn” and “debt is a deadly plague.” Yes, that simple. When you’re in an emergency, simplicity works.

Before I discovered simplicity, I used to have a lot of clever ideas. And my cleverness got me into trouble. One of the ways I was clever was that I always pushed things back so I could enjoy them today but pay for them tomorrow. The future would always be brighter and I would always be able to pay.

I remember calling the credit card company whenever I got a raise at work: “hey, I got a $10,000 raise on my yearly salary today, so I’d like to increase my limit,” “sure sir, let me look into that.” Ayayay…

Trouble ensued, of course, in spite of my cleverness. The way I see it, I didn’t get in trouble because I wanted to be broke. It’s like that truism that no child ever says: “when I grow up I want to be a drug addict.”

In my case, I can tell you that I was full of good intentions, that I wanted to prosper, and that fortunately I’m not an addict, but I was extremely ignorant about money. I really knew nothing about it and I didn’t know how to control it. And money, powerful force that it is, took control of my life instead, and nearly destroyed me. Just like, you know—fire.

When I say I was ignorant about money I don’t mean that I didn’t get the math. I love math. Math is simple and beautiful, clear, elegant, and value-free. Money on the other hand is complicated, laden with conflicting values, charged with emotions, and it smells. I always got math. I just didn’t get money.

Today, in spite of my dark past, I feel in pretty good control of my finances. I’ve read books, I’ve paid attention to money, and I’ve been following GRS for the past couple of years. In that time I’ve learned a few useful things, simple and basic things that work and require no great cleverness.

For example, I’ve learned that money is not intrinsically “bad,” that it’s not base or vulgar to pay attention to it, that the world owes me only what the market is willing to pay for my services, and that I need to spend less than I make every day instead of gambling that my ever-prosperous tomorrow will pay for today’s bills.

Today I have a little emergency fund. I’m repairing what’s broken and I’m paying the taxman. And I’ve started to focus on making more money: small steps right now, like charging more for my services, and taking a side gig (this one at GRS, for starters). I’ll get better as I go. So now I’m getting rich slowly, I suppose. Very, very slowly! I own practically nothing today, but compared to what it feels to be in the hole, as I was before, there’s a world of difference.

And how did I do this? With your help, of course, and the help of others. By reading and thinking and writing about personal finance every day, I’ve acquired basic knowledge that dispelled old damaging illusions and has allowed me to get my house in order. Now I think I’m ready for the next step.

The State of our Knowledge
The problem, as I see it, is that we have all kinds of ad-hoc financial advice out there, but we have no theory to test things against, and no real basic principles, so the advice we get is often contradictory. I used to drive my wife crazy trying to follow one financial guru after another.

Of course the experts will disagree among them, but sometimes writers contradict themselves, often through no fault of their own because they are working with useful pieces of information that happen to contradict each other.

As you know I’m a loyal GRS reader, so I remember this post from J.D. last New Year’s Day. I really loved it, and I added the link to my GTD with the note: “adopt financial blueprint for the year”. However, as much as I vouch for it, I still can find contradictory information in it. It’s not J.D’s fault, it’s just the nature of the subject.

If you look there, step 2 is tracking every penny you spend, and the article suggests many ways to do that. So far, most of us agree this is a good thing. Step 3 then recommends that you adopt a budget, and suggests Elizabeth Warren’s Balanced Money Formula. Here’s the thing though: Warren is adamantly against tracking every penny. She considers it impractical, a nuisance, and a waste of time that discourages people. So, what is it? To track or not to track, that is the question!

The way I’m trying to describe things, again, I am convinced this isn’t anybody’s fault: J.D. prospered by tracking his pennies, so he stands behind that. And Elizabeth Warren is great as well, so why not recommend her. But the two systems don’t connect. And for now, until we have a theory that explains all things PF, that’s acceptable — as long as can we manage to prosper in spite of the disconnect.

The Uncertainty Principle
The world of personal finance is rife with contradictions because it’s not based on hard data, and there are very few overarching principles that most of us can agree upon.

I have no problem with a situational approach if it works, but the thing is, in other areas of life we have things figured out a little better — or at least we’re pretending more intently, like when we calculate the mechanical energy of an object in motion given its mass and speed, or when lawyers discuss whether a law is constitutional or not.

In personal finance we don’t seem to have a lot of foundational concepts, the way Newtonian mechanics has its three laws, or chemistry has the periodic table of elements. Finance is a subject intricate enough; add the personal element and it can soon become a free-for-all, even outright quackery (et tu, Suze…).

The problem is that knowledge is a tough business. Even in the hard sciences, which by comparison deal with very simple phenomena, we have to make do with incomplete explanations: Newtonian laws don’t apply to very high speeds, nor to very small distances, so we had to come up with other theories to deal with those things.

And now the problem is, those two other theories (relativity and quantum mechanics) don’t connect with each other, and physics, in spite of all its recent discoveries, still doesn’t have a Theory of Everything to explain the physical world (it also has a bunch of other big, unsolved questions).

I Know One Thing — That I Know Nothing
Human life is much more complex than the stuff of physics, and is infinitely more contradictory. For example, we lack anything even remotely close to a “moral science” that could predict (every time, with statistical certainty, and deducted from its basic principles) what is the right decision in each situation. Some people have tried to come up with such solutions, but this usually involves either infinite hairsplitting or outright brainwashing (“What did you say you put in this Kool-Aid, exactly?”).

However, in spite of the limits of our understanding, we desperately need rational, sensible, actionable knowledge in order to make the right decisions. And the more fragmented, chaotic, uncertain and contradictory our information, the harder it is to learn anything from it, and the easier it is for people to engage in irrational, self-destructive behavior.

J.D. wrote at the end of last year that financial literacy solves nothing, because our problems are behavioral. He further went ahead and introduced the notion of behavioral finance, and made a critique of consumerism. I agree with him from that perspective, but I’ve also come to realize that understanding money requires more than understanding the math, and that there’s more to it than mere behavior.

Financial literacy, if we are to define it as the basic understanding of money, requires an understanding of the philosophical, psychological, social, and even spiritual aspects of money in our lives—in addition to the math. To steal an expression from the late Steve Jobs: Personal finance is a liberal art.

My GRS Quest
Obviously there can’t be a Theory of Everything in personal finance, so it should be clear by now that the title was meant humorously. Even if we could all agree on something as basic as “spend less than you earn,” someone would come up with a case where some outlier just happened to spend more than they earned and somehow got rich anyway and lived the dream and died before blowing through their piles of money and/or debt—and our axiom would be instantly demolished. And because of this, we cannot expect to approach personal finance the way we approach hard science.

Still, for all the diversity of information and contradiction out there, I want my project to be one of connecting the dots, of seeking basic principles and distilling ideas, and of finding ways to relate them coherently, so that others can learn and understand and put ideas to practice without getting confused in the process.

I also want to avoid, if possible, the fundamentalism of oversimplification. Sometimes oversimplification can get us out of trouble, and this can give it a place in our lives, especially in times of emergency. E.g.: “When you hear this alarm, exit the building.” No ifs, ands, or buts.

Reading Dave Ramsey a couple of years ago was very good for me in a financial crisis. It provided me with an easy way to approach things and to avoid rationalizations. However, while it was good in an emergency, it become too rigid a model when the emergency had passed. It was the fundamentalist approach to financial recovery, if you will.

And life is, after all, a complex affair; we need mental models that can deal with such complexity, and deal with it realistically — because complexity should not be an excuse for the rationalization of self-destructive behaviors.

I suppose what I’m after these days is not an easily marketable “recipe for success,” or a reproducible program of some kind, but rather I’m after some sort of “philosophy of prosperity,” if I dare call it that. Of course it would be mad ambition if I considered this to be a final, achievable goal; but the way I see it, this is just as a direction of travel, a point in the compass.

Anyway, I might have managed to connect a few dots and distill one useful idea for you today, after all. The idea is simply that approaching personal finance as a liberal art might help us get a better grasp of this stubbornly irreducible subject. And that’s what I intend to do here at GRS.

So this is what I bring to the organization, my dear readers: a love of complexity and a thirst for coherence. And as I begin my work here, I ask you to kindly assist me in my travels (or troubles!) and continue sharing with me the things you know, and challenging me, as you always have.

Oh, and to the question “Where do you see yourself five years from now?” my answer is: sitting on a huge pile of money, of course! (Fingers crossed, my friends, fingers crossed…)

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This article is about Odds and Ends