Which financial advice should you trust?
Commenting on a recent article, Carmine Red asked an excellent question:
How do you evaluate the financial advice you get from other sources? Specifically, how do you decide if some piece of advice is for you, or if you should discard some adjacent advice. Is there an amount of pick-and-choose?
GRS definitely doesn’t seem like a dogmatic 100% one-way-of-doing things site, so I’d love to hear about the critical thinking you employ, and that I’m sure we can all use a little of since we’re getting bombarded by financial “do this!” or “don’t do this” instructions from so many different dimensions.
Carmine is right: GRS is not dogmatic. From the start, my top admonition has been “do what works for you”. By this I mean that you should test financial advice to see if it works for you and your situation. There's little (if any) advice that applies to 100% of people in 100% of cases. Life is messy. Money is messy.
So, how can you decide whom to trust? How can you evaluate a piece of financial advice to decide whether it has merit? And if the financial advice does have merit, how can you tell if it's right for yor life?
Today, let's take a deep dive into this question. Let's explore how to evaluate all of the financial advice you get — from the internet, from television, and in real life.
How to Evaluate Financial Advice
Before I answer Carmine's question directly, I want to approach it obliquely. If you find this section boring, please skip to the next one. I won't hold it against you!
In 1940, Mortimer J. Adler published How to Read a Book, which contained 400 pages of advice on doing something that most people would argue needs no instruction. In 1967, he revised the book and turned it into a little masterpiece.
In the revised edition, Adler argues that there are four levels of reading:
- Elementary Reading. At this basic level, the reader is able to answer the question, “What does the sentence say?” But reading at this stage is a mechanical act.
- Inspectional Reading. At this level, a reader's aim is to get the most from a book (or article) in a minimum of time. “Inspectional reading is the art of skimming systematically,” Adler writes. Your aim is to get a surface understanding of the book, to answer the question, “What is this book about?”
- Analytical Reading. At this level, you're doing the best, most complete and thorough reading of a book that you can do. Inspectional reading is done quickly. Analytical reading is done without a time limit. Its aim is understanding. This is the sort of reading that most of us do most of the time.
- Synoptical reading. At the fourth (and highest) level of reading, we read comparatively. “When reading synoptically,” Adler says, “the reader reads many books, not just one, and places them in relation to one another.” My ongoing project to read about the history of retirement? That's synoptic reading.
What has this to do with evaluating financial advice? Well, I think similar principles apply. When you receive a piece of financial advice from somebody, or you read a recommendation online, there are four levels of evaluation.
- Elementary evaluation. When you pick up a piece of financial advice, start by asking yourself “What does this advice say?” You're not trying to judge its merits. You're merely trying to parse the recommendation. Believe it or not, you can throw some stuff out at this level because it doesn't say anything. Or what it says is nonsensical. (I don't mean nonsensical as in “I disagree with it”. I mean nonsensical as in it literally makes no sense.)
- Inspectional evaluation. Next ask, “What is this advice about? What is the overall message? What is its core argument?” You're not trying to understand nuance here. You're trying to get the main point. For instance, in Mr. Money Mustache's popular article “The Shockingly Simple Math Behind Early Retirement”, the core argument is “the more you save, the sooner you can retire”. The main point of the article you're reading right now is: “There are smart ways to evaluate financial advice. Here are a few.”
- Analytical evaluation. The biggest part of evaluating financial advice is taking time to analyze it, to examine the advice in detail, to really understand it. This usually means asking “why?” Why is the person giving this advice? What's their motivation and what does this advice aim to accomplish? (The rest of this article offers some tips for applying this step.)
- Synoptical evaluation. Lastly, if you're evaluating important advice (such as how much to spend on a house), you should make time to do some comparative evaluation. What do other people have to say? Why do they agree? Why do they disagree? How does this advice fit in to what you already know and what you're already doing?
Here at Get Rich Slowly, one of my primary aims is to “evaluate synoptically”. I don't want this site to be one-dimensional. When I write my articles, I try my best to draw from a variety of disciplines and sources. I look for differing opinions. Does that mean I stray from strict personal finance sometimes? Yes, absolutely. But it makes the writing more interesting for me and, I hope, for you.
Okay, that's some semi-helpful, high-level philosophical stuff about evaluating financial advice. Now let's look at how to put this into practice. How do you actually analyze financial advice to decide whether it's good or not?
I think it helps to ask four questions.
Does This Advice Mesh with Reality?
Some advice sets off my Bullshit Detector. Rhonda Byrne's mega-bestseller The Secret [my review] is a classic example of this. Byrne claims that your life is created by the things you think about. There's an element of truth to this, but she takes it to an illogical extreme.
I mean, look at this bullshit:
Thoughts are magnetic, and thoughts have a frequency. As you think, those thoughts are sent out into the Universe, and they magnetically attract all like things that are on the same frequency. Everything sent out returns to its source. And that source is You.[…]
To lose weight, don't focus on “losing weight”. Instead, focus on your perfect weight. Feel the feelings of your perfect weight, and you will summon it to you.
It takes no time for the Universe to manifest what you want. It is as easy to manifest one dollar as it is to manifest one million dollars.
The financial “advice” in The Secret is premium, high-grade bullshit. It doesn't mesh with reality. I know from experience that I cannot “manifest” a million dollars. I cannot “visualize checks in the mail” and then have them magically appear. (Seriously, that's one of the bullet points in her book: “Visualize checks in the mail.”)
This is an easy example. Usually, it's more difficult to determine whether financial advice is reality-based.
For instance, there are a lot of investing systems out there. Their proponents sincerely believe in them. They can be passionate when they explain how their systems work. Testing whether or not investing advice meshes with reality can be complicated and confusing. I find situations like this frustrating, which is why I try to avoid overly complicated advice in favor of simplicity.
This brings up a tangential but important point. When possible, I favor simplicity.
Yes, absolutely yes, money can be messy. It can be complicated. And not all complicated advice is bad advice. Some complicated advice is great, in fact. Todd Tresidder at Financial Mentor has built his entire brand on complicated advice. But he's not a charlatan. He's the real deal.
For me, though, Todd's financial advice is overly complicated. I prefer simple. I'm an “80% solution” kind of guy. That's why I'm good with Dave Ramsey's version of the debt snowball, even if it's not mathematically optimal. That's why I like investing in index funds. These strategies are simple and effective even if they don't provide optimal results.
Is This Person Qualified to Give This Advice?
I've found that people are quick to offer advice on subjects for which they have little or no understanding. And, in fact, it's usually the people who know the most about a subject who are slowest to make suggestions — and their suggestions are full of caveats and qualifications.
I have several friends who love Bitcoin as an “investment opportunity”, for example. Yet, these same friends don't understand the fundamentals of basic investing. It's difficult for me to take their cryptocurrency recommendations seriously when they can't explain what a stock is and why you might want to own one. Or a bond. Or any other traditional investment. They might understand the technical details behind Bitcoin, but they don't understand investing, so I don't listen when they try to sell this as an investment opportunity.
This same principle applies to financial gurus. Sometimes an expert in one field tries to offer advice in a related field, but that advice isn't necessarily good.
- Dave Ramsey is an expert on debt reduction. He's lived it. He's been teaching about it for twenty years. He knows what works and what doesn't. I trust his debt advice. I do not trust Ramsey's investing advice. He makes bold claims that are demonstrably false.
- On the other hand, I trust Warren Buffett's investment advice. He's one of the greatest investors the world has ever known. When he says that 99% of investors ought to use index funds, that carries a lot of weight. But if he were to offer advice on getting out of debt, I would treat it with some skepticism. Buffett has never been in debt and cannot understand what the experience is like.
I can't think of any expert I trust 100% about all topics. I don't believe it's possible for a person to know everything about everything. Plus, so much of personal finance is personal, right? Sometimes an expert's advice might be right for most people but, for whatever reason, it might not be right for you.
I am not a trained financial professional, and I try to make that abundantly clear at all times. Anything I know, I've learned from the school of hard knocks. Because of this, I do my best to be transparent about what I do and do not know.
When I write about investing, for instance, I cite my sources. I explain where I'm getting my information and why I believe it. I don't expect you to accept my recommendations because I am the one making them. But if I can show you how I learned something, maybe it'll be useful for you too.
On the other hand, I'm an expert at making mistakes. You should trust me there haha.
How Does This Person Profit from Their Advice?
I'm generally a positive, trusting fellow. I'm probably too trusting. I believe that people are generally good.
That said, I've learned to be skeptical when people offer financial advice. Do they have an ulterior motive? How might they benefit from the advice they're offering? If they benefit, how does that color their recommendation?
I'll offer me and my colleagues as prime examples.
I've written before about how bloggers walk the thin green line. Most bloggers mean well, but their intentions get clouded when they see how much money they can make writing about this product or that service. Their advice can turn from selfless to selfish.
Here's a specific example. I almost never trust online credit card and bank reviews. These reviews are not objective. Their aim isn't to provide you with the info you need to make a decision, but to encourage you to sign up for an account. And bloggers employ all sorts of subtle methods to make that happen. I don't like it.
This is the primary reason you've never seen me do a credit card review. I do want to review the card I use most often, though, and I've been working on an article about it for nine months now. When I publish that post, you can be sure the review is based on my experience and I'll offer disclaimers if I make money from the review.
(Trivia: Until this year, I had never made a penny from credit cards. Zero dollars. Zero cents. That's changed now, though, since the introduction of our travel credit card tool. Now I've made a few hundred dollars from credit cards.)
At the opposite extreme, look at somebody like Mr. Money Mustache. When he writes about things like getting rich with bikes, he has no ulterior motive. He's not trying to trick you into putting money into his pocket by buying a bike. He doesn't profit from this recommendation.
Instead, this is something that Pete believes. He believes that biking is better for your health and your wealth. It's advice he adheres to himself, that he puts into practice daily. And because this is genuine advice without a financial motive, I'm more likely to accept its validity.
This idea even applies to professionals. A real-estate agent is probably prevented from steering you to the most expensive house, but there's nothing preventing her from spouting nonsense like, “You should buy as much home as you can afford.” That's dangerous advice that puts people into precarious financial situations — yet generates a bigger commission for the agent.
Always ask yourself how the person giving advice stands to benefit from the advice they're offering.
What are the Other Options?
When you're trying to decide whether or not to accept a piece of financial advice, explore other alternatives. Seek other options and approaches.
It's very rare in the world of money (and the world in general) that there's just one way “right” way to do something. There are often multiple good approaches to a problem. This can make it tough to pick the one that's best for you.
Budgeting is a great example. There are dozens (hundreds?) of different approaches to building a household budget. Choosing a system can be overwhelming. How can you decide which choice is best?
Honestly, you can't. And you shouldn't even try.
Instead, forget about “best”. Focus on “good”. When selecting a budget system, use trial and error until you find one that works well for you. Once you've found a budget that works, stop actively pursuing other options. Don't close yourself off to the idea that you might stumble upon a better option in the future, but stop expending energy trying to find a perfect solution when you already have one that works.
A corollary to this principle is that you shouldn't stick with a piece of advice simply because somebody told you that it's the best (or the “right”) way to do something. Who cares? If the best (or “right”) way isn't effective for you, then let it go.
My friend Paula Pant once told me, “An imperfect plan you'll stick with is better than a perfect plan you won't.” Exactly.
From day one, my motto here at Get Rich Slowly has been: Do what works for you. If something isn't effective for you and your situation, abandon it. Don't stick with something out of the mistaken belief that you're a failure for choosing another option.
Guidelines for Evaluating Financial Advice
Evaluating financial advice is an extension of critical thinking as a whole. If you become a better critical thinker, you'll make better decisions regarding the advice you receive. And the more you practice, the better you'll become.
For my part, I've been reading about personal finance extensively for the past fifteen years. In that time, I've read (and heard and viewed) all sorts of advice, much of it contradictory. At first, I found this confusing. In time, though, I've developed a set of rules (or guidelines, if you prefer) to help me better evaluate the financial advice I receive.
Here are a few:
- If it sounds too good to be true, it probably is. (I want to say, “It always is” — but I hate absolutes.)
- Verify, verify, verify. Don't blindly follow somebody's advice. If someone makes a suggestion that sounds reasonable, research what others say both for and against the suggestion.
- Don't throw the baby out with the bathwater. If you're an atheist, don't ignore Dave Ramsey's debt advice simply because he's Christian. If you're conservative, don't dismiss Elizabeth Warren's balanced money formula simply because she's a far-left liberal. Even folks you don't like can have smart ideas.
- Favor simplicity. Complicated advice and complicated systems too often hide flaws and problems and traps. Plus, complexity leads to misunderstanding. With money, simplicity is a virtue.
- You don't have to take every piece of good advice. I recognize, for example, that real-estate investing can be profitable. It's an excellent way to build wealth. Still, I don't want to do it — so I don't.
- Check certifications, when applicable (especially when asking for technical and/or legal advice). You can good advice from folks without credentials, and you can get bad advice from experts. But generally speaking, qualified experts are a terrific resource.
Plus, I've learned to ask four basic questions when I'm evaluating a new piece of financial advice.
- How does the person giving the advice profit from it?
- How do I benefit from the advice?
- How does society benefit from the advice?
- Has the other person been successful following their own advice?
This last question is important. If this article weren't so long already, I'd dive deeper into it. But let's quickly use Bitcoin and index funds as an example. When people recommend Bitcoin to me, I ask how they've done with their “investments” in cryptocurrency. (Typical answer: Not well.) Same thing with index funds: “How have you done?” (Typical answer: Fairly well.)
People love to throw out advice that either they don't follow or that hasn't actually worked for them. I'm not sure why that is, but it's true.
For my part, I try to steer clear of things I don't understand. I'm not perfect. I make mistakes. But when I make mistakes, I try to fix them as quickly as possible. Also I'm willing to learn. When I started GRS in 2006, I didn't know what an index fund was. I thought investing was all about picking stocks. Then I learned about passive investing. Today, I have a more nuanced approach.