Beneath the Surface

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While not denying that personal financial planning can be useful, Helaine Olen emphasizes its shortcomings and its dangers. In a society where fewer jobs offer pension benefits and realistic prospects for upward mobility, personal saving and investment cannot provide economic security for enough people. Moreover, aggressive marketing and exaggerated claims by the financial industry are part of the problem. Financial institutions and their agents too often take advantage of people’s financial fears, economic insecurity and lack of information to steer them to financial products that profit the seller more than they help the buyer.

That being the case, one might expect Olen to support efforts to improve Americans’ financial literacy. This solution appeals both to liberals who want to empower people and conservatives who want them to take more financial responsibility. High schools in 25 states now require some form of financial education, and 13 require a semester-long personal finance class. So far the results are not encouraging: “By almost every available measure, the financial literacy of the American public has remained dismal in the almost two decades since the movement began.” Maybe one semester in high school isn’t enough. To be effective, finance might have to be as integral a part of education as the learning of second languages is in some countries (my analogy, not Olen’s). But Olen sees a deeper reason why financial education is ineffective: “The financial literacy movement…is led by the very people who have the most to gain by society’s continued financial ignorance: the financial services sector.” Financial services companies sponsor many of the financial literacy programs and have a hand in developing and selecting materials for them. Creators of the materials often pitch them not directly to the schools, who often lack money to spend on them, but to financial firms seeking to generate interest in their products on the part of a new generation of consumers. Protecting consumers against financial products and practices that serve them poorly is unlikely to be a focus of the materials.

Another reason why education and advice may not have much impact on people’s financial behavior or economic condition is that they have deep-seated psychological dispositions that interfere with rational decision-making. Just as some people have learned to associate food with all kinds of good stuff (food = love) to the point that they overeat, some people have such positive associations surrounding money that they habitually overspend. So people don’t just need financial literacy, they need financial therapy, another wonderful product to sell to people with money problems. Once again, Olen acknowledges that this can work for some people–especially those who can afford a personal financial coach or therapist–but it can hardly be a cost-effective solution to widespread economic insecurity. Here Olen cleverly turns the popular food analogy around. Yes, some individuals have food hangups, but that won’t explain why the number of obese people has doubled since 1980. A corollary of the widening income gap is a widening nutrition gap, with expensive fruits and vegetables for the affluent and cheap but low-nutrition/high-calorie food for the poor. Similarly, the gap has been widening between vastly different financial behaviors: more investment and wealth accumulation by the affluent, but more cheap WalMart goods and easy subprime credit for the poor. Those who deplore lifestyles centered around borrowing and spending rather than saving and investing should see them as more than just a manifestation of personal pathology.

What Olen is trying to do with the whole book is shift the national conversation from personal finance to social financial conditions:

The financial therapists were right. We needed to talk about our money. But they were wrong too, because to speak about our money solely in a personal sense is to miss the nature of the problem. We needed to discuss our money collectively because our financial lives were not falling apart one by one. We were–and are–going down together, but most of us just didn’t realize it.

The book is rather thin on solutions, perhaps because the best solutions would require sweeping economic changes like a new expansion of the middle class. (Some reviewers have said that she should give more personal financial advice of her own, but they seem to have missed the point of the book.) She does mention several social reforms relating directly to personal finance:

• More vigorous consumer protection: Hopefully the new Consumer Financial Protection Bureau will help there.
• Broader application of the fiduciary standard: The requirement that financial recommendations be based on the best interests of the client should apply to those who sell securities and those who manage retirement accounts.
• A national pension system to replace 401(k)s and similar company plans: Benefits could then be guaranteed instead of dependent on individual investment success. Although it seems radical, I would say it’s no more radical than a single-payer system for health insurance, which is more common in the world than this country’s reliance on private insurance.

If the economy continues to have a strong recovery, and if today’s retirement accounts prove sufficient for most people’s economic security, then interest in such reforms may wane. But if Olen is right when she refers to “The Coming Retirement Train Wreck” (Ch. 4’s subtitle), then the book may contribute to a rethinking of the current American approach to financial progress. Maybe in a few years we will look back on recent decades as a time when we went a little crazy with the notion of do-it-yourself financial success.

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Before continuing with Helaine Olen’s critique of the personal finance industry, I’d like to frame the issue a little differently, using the idea of empowerment. I want to credit Knight Kiplinger, Editor in Chief of Kiplinger’s Personal Finance, for getting me thinking along these lines. In a recent editorial, he takes Olen to task for portraying Americans as “powerless victims,” for whom individual initiative and personal financial advice cannot provide financial security:

For more than 65 years, this magazine has tried to educate the American people about how to manage their money wisely to achieve basic financial security in good times and bad.

Judging from the testimonials we get from our readers, we’ve done a pretty good job of it by focusing on the basics: living simply, deferring gratification, putting saving on autopilot, reducing risk with insurance and diversified assets, and avoiding investment fads. Despite the financial challenges of the past dozen years, I fervently believe that financial security is still achievable by every productive American.

I was struck by how easily Kiplinger slides from talking about his own readers to generalizing about “every productive American.” The typical subscriber to Kiplinger’s–and I am one–probably does have a reasonable amount of power: an above-average income and a high level of financial literacy. Such people are not so likely to be financially victimized. And yet even my well-educated, economically successful clients have often come to me with portfolios weighted down by high-fee, low-performing investments they got from a “financial advisor” whose main job was selling. Power is a relative thing, even at the higher end of the scale.

Below that higher end, millions of other productive Americans are much less empowered, and the recent flow of income gains to the wealthy, along with the reduced chances of upward mobility–both well documented–are helping to keep them that way. But the heart of the personal finance ideology described by Olen is the message that you have the power to be successful, along with its corollary that if you don’t achieve success, it’s entirely your fault. Isn’t this just the old individualistic work ethic being used to justify an increasingly unequal society, just as it did in the Gilded Age? Kiplinger cites the historic progress of women, racial minorities and immigrants as evidence that individual initiative works and more “government help and regulation” are unnecessary. And yet none of those groups got ahead without a series of public policy changes, from collective bargaining rights to anti-discrimination legislation. Yes, we’ve had social progress, but is American society in such great shape and our citizens so empowered that no further social changes are called for?

For Americans who are struggling to find decent jobs, or pay for health care without insurance, or afford a home in a safe neighborhood with good schools, or send a child to college, the “you have the power” message rings a little hollow. And it becomes downright dangerous when it becomes a marketing tool to sell financial products that benefit the seller more than the buyer.

The chapter in Pound Foolish that I found the saddest was Ch. 8, “Who Wants to Be a Real Estate Millionaire?” Olen briefly reviews the history of home ownership, beginning with a time when most Americans were renters, and home mortgages were only for those who could pay them off quickly, usually within three to five years. Home ownership got a big boost from the 30-year mortages promoted by the New Deal administration of Franklin Roosevelt, as well as by the mortgage subsidies included in the G.I. Bill. For a long time, banks were careful to lend only to borrowers whose incomes could support the fixed payments. But that changed in the 1980s and 90s:

Looser bank regulations combined with advances in computer and securitization technologies and changes in government regulations begat a new wave of mortgage innovation. Now there were mortgages offered to buyers with no money down, variable interest rates, interest-only payments that would balloon with time, and so-called “no doc” loans which allowed buyers to state their income while offering little or no proof of it.

One can fault the borrowers for getting in over their heads, but they got a lot of help from the financial services industry in general, and from the purveyors of personal finance ideology in particular. David Bach, who had first achieved celebrity by telling readers that they could become millionaires by giving up little luxuries like lattes, now wrote The Automatic Millionaire Homeowner, saying that “It’s never too late to catch the real estate wave” (great advice, if you live on a planet where bubbles never burst). Bach and the many other writers of his kind kept promoting the American Dream of building wealth, at a time when the normal means of doing so–improvement in real wages–was available to fewer workers than it had been during the postwar economic boom. This time, the increase in homeownership was based more on excessive debt.

Then the promoters of do-it-yourself enrichment went even further, touting an even faster way of becoming a millionaire: flipping houses for profit. Here the leading voice was Guy Kiyosaki, whose Rich Dad, Poor Dad belittled the traditional way of getting ahead, through education and employment. Unlike the “losers” who tried to do it the old-fashioned way, Kiyosaki claimed to have made his fortune in real estate, a fortune, according to Olen, “that no one has ever been able to prove existed before his bestselling book turned him into a multimillionaire.” He steered his readers toward wealth seminars offered by organizations with which he partnered, one of which Olen attended.

The majority of the time in these seminars is not devoted to the secrets of real estate investing, but instead, selling attendees on even more “advanced” courses costing anywhere between $ 12,000 and $ 45,000. “About 70 percent of the time has been spent on the sales pitch and building up the belief in peoples minds that without them they won’t succeed in this business,” wrote one attendee….

The advice in such courses emphasizes the potential gains but not the risks, to put it mildly. People of limited means are even encouraged to get started by charging to their credit card the down payment on their first property. Then they are to flip it for a quick profit and be on their way to prosperity.

Certainly many, if not most of those who got caught up in such schemes were not so much empowered as victimized. They were victimized first by our winner-take-all economy, where the traditional routes to success didn’t work as well as they used to. They were victimized by hucksters who sold them little besides empty promises. Finally, they were victimized by the crash in housing prices, “a huge contributor to the almost 40 percent fall in the median net worth of American households between 2007 and 2010.

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Helaine Olen. Pound Foolish: Exposing the Dark Side of the Personal Finance Industry. New York: Penguin Press, 2012.

As someone who has worked as a personal financial planner myself, maybe I should be upset by Helaine Olen’s scathing critique of the industry. Fortunately, I never went over to the “dark side,” as far as I know! I tried to give my clients insight into their financial situation, along with a dose of what Olen calls “basic, commonsense advice.” Live within your means. Get the power of compound interest working for you (by saving) instead of against you (by borrowing). Distinguish between reasonable risks, like putting a portion of your savings in stock for a long-run return, and unreasonable risks, like betting too much on any one investment. Diversify within asset classes, such as by owning many different stocks and bonds, and allocate sensibly among asset classes. Avoid unnecessary fees and expenses. Look for buying opportunities when an asset class is cheap, but don’t chase performance, buying whatever’s hot and selling whatever’s not. Take advantage of tax-sheltered investing. Plan to make your assets last with prudent withdrawal rates in retirement.

Olen acknowledges that this kind of personal finance “can make a valuable contribution, allowing us to plan, to get out of and stay out of debt, and to hopefully better our position when the time comes for retirement and other long-term goals.”

Olen’s complaint is that “personal finance went from aid to ideology.” It got entangled with a revival of American rugged individualism, the belief that economic progress is a matter of changing individuals one by one, instead of changing any business or government policies. “Seemingly beginning in tandem with the presidency of Ronald Reagan, we began to doubt the collective spirit of Franklin Roosevelt’s New Deal, and once again romanticized the pull-yourself-up-by-your-bootstraps ideology of Horatio Alger.” Social reform was out of fashion, and getting rich on one’s own was in. The story of Olen’s book is “the story of how we were sold on a dream–a dream that personal finance had almost magical abilities, that it could compensate for stagnant salaries, income inequality, and a society that offered a shorter and thinner safety net with each passing year.”

Ironically, the dream of getting ahead through saving and investing became more popular just at a time when real prospects for upward mobility were declining. “About 60 percent of the gains in income between 1979 and the 2000s went to the top 1 percent of earners.” Not only were wages stagnating for many workers, but the percentage of workers covered by traditional pension plans was declining steadily, from 62% in the early 1980s to half of that recently. Defined contribution plans, in which the individual worker assumes the risk of investment failure, replaced defined benefit plans, in which the employer was responsible to pay what was promised. Olen cites research showing that pension funds “offered their enrollees greater returns for lower cost, thanks to their stable, long-term professional management and lower expenses.” Although the richest 10% of households own over 80% of the stock, the requirement that workers save for their own retirement brought millions of small investors into the market.

The boom in individual investing was a bonanza for financial professionals, who could sell their services both to employers with 401(k) plans to manage and individuals who were buying their own securities, either in IRAs or taxable portfolios. Before 2012, managers of 401(k)s had no legal obligation to disclose to contributors the fees they charged to manage their contributions. Fees are crucial, because even small differences in fees can compound into big differences in asset balances by retirement.

The media also played a large role in promoting the ideology of personal wealth creation. They found it more profitable to celebrate the investment boom and the growing financial services industry than to scrutinize them from a consumerist standpoint. Their financial advertisers loved it, since the mere mention of a mutual fund in a financial magazine would draw money to that fund.

Markets work most fairly when buyers and sellers can transact from a position of mutual knowledge and strength. But most Americans were at a significant disadvantage in dealing with the “personal finance industrial complex.” They were faced with the responsibility to save and invest more to pay for retirement, as well as to finance increasingly expensive health care and children’s educations. But they were both financially insecure and poorly informed about financial matters, which made them easy targets for aggressive marketers. Olen describes a number of ways that purveyors of financial advice have enriched themselves while poorly serving those they purported to help:

• Media celebrities like Suze Orman and Dave Ramsey have made a fortune preaching a pseudo-religious gospel of personal financial salvation. The key to economic success is to transform oneself from financial sinner to financial saint. Ramsey, a self-confessed deadbeat who declared bankruptcy in 1990, got religion when he read Proverbs 22:7: “The borrower is the slave of the lender.” He then made his money preaching against debt in print, on the radio, and in public appearances, as well as by charging fees to financial professionals who wanted customer leads from among his followers. These celebrities do not usually make their money through their own investing skills, but from successfully marketing their ideas and products to others.
• Many stockbrokers, financial writers and media personalities promote individual stock picking as the key to success. Olen calls individual stock trading a “loser’s game,” although she doesn’t clearly explain why. (Essentially, it’s because individual investors have trouble knowing anything about a company that many others don’t also know. You may be able to see that a company is doing well, but if lots of other people know it too, then the stock may be priced too high to be a superior investment. What moves the price will be new information, but new information is hard for you to get first, unless you engage in illegal insider trading!) The illusion that any smart investor can beat the market leads people to pay brokers too much for frequent trading, or pay mutual fund managers too much for funds that usually don’t beat the market anyway. Stock pickers like CNBC’s Jim Cramer, whose own picks tend to spike briefly and then dive, do a great disservice by promoting this game instead of more prudent investment practices. Many studies have concluded that a portfolio consisting mainly of low-fee, no commission index funds works out better for most small investors.
• Most Americans of modest means cannot afford to pay hourly fees or an annual percentage of their assets to get professional advice. They have to rely on “free” advice from brokers or insurance agents. Those who offer that advice are usually sales agents whose recommendations are biased toward the products from which they earn the largest commissions. When brokers were presented with sample portfolios by actor posing as investors, the brokers “did almost everything wrong, from refusing to correct client investment biases to pushing high-cost active management over lower-cost and more efficient index funds, likely out of a desire to increase their own bottom line. Moreover, they almost always recommended massive portfolio changes, even if none was called for.” Insurance companies are notorious for offering customers products so complicated and weighed down by hidden fees that even professional planners can have trouble evaluating them. (I know, because my clients have often brought them to me.) They are also especially resistant to the idea of being bound by a “fiduciary” standard, requiring them to recommend only products that are in the best interest of their clients.

Olen is a financial journalist, not a Certified Financial Planner or other financial professional. She doesn’t analyze financial products in any depth, such as explaining the differences among different kinds of annuities. (For most people, an immediate annuity with a fixed payment is a much simpler and useful investment than, say, an equity indexed variable annuity.) By relying on relevant examples and the research of others though, she makes her case that in the present economic environment, personal finance does indeed have a dark side.

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