They often do what behavioral economists call "mental accounting," earmarking special money for this and that. Of course, many people don't think this way. ![]() Absent some financially advantageous reason to do so (like the ability to get subsidies or a lower tax rate), it doesn't make sense to set aside savings for specific purposes, like a new car or a future vacation or a down payment on a house. That being said, I do think that there is something to this notion of being disciplined and learning to live within your means at a young age." How Should You Think About Your Budget? "On the one hand, I do have a lot of sympathy for the view that you might be unnecessarily depriving yourself in your twenties and even thirties when, very predictably, your income will likely be much higher in later decades. So who wins on this point? "I'm actually agnostic about it," Choi says. This motivation, he says, "is almost always missing from economic models of optimal saving - a potentially important oversight." In other words, some of us might need to adopt hard-and-fast saving rules at a young age to develop the discipline needed to lead more affluent lives, even if that's less than optimal from a traditional economic perspective. Where thinkfluencers and old-school economics really depart from each other, Choi says, is "the usefulness of establishing saving consistently as a discipline," Choi says. Of course, economists also recognize the power of compound interest. As a result, wealth snowballs over time, so saving a large percentage earlier could make a lot of sense. The longer you save money, the more interest it accrues. In arguing this, the thinkfluencers often cite the power of compound interest. It doesn't matter if you're 20 or 30 or 50 they implore you to stash money away immediately and invest it for your future. ![]() Reading through popular finance books, however, Choi finds that the vast majority of popular authors offer advice that contradicts this approach: throughout your life, the thinkfluencers say, your goal should be to live within your means and save a consistent percentage of your income. Once they start making money, he says, they should probably pay down that debt quickly since credit card companies charge high interest rates. ![]() "I tell my MBA students, 'You of all people should feel the least amount of guilt of having credit card debt, because your income is fairly low right now but it will be, predictably, fairly high in the very near future,'" Choi says. You want to smooth that over time." The sort of ideal scenario: you start off adulthood saving little or nothing or even taking on debt, then you save a lot during your prime-age earning years, and then you spend those savings when you retire. The idea, Choi says, is "you don't want to be starving in one period and overindulged in the next. Economists call this "consumption smoothing," and it's a feature of standard economic models of how rational people save and invest over their lifetime. That's because you're likely going to earn a bigger paycheck when you're older, and to really squeeze the enjoyment out of life, it might make sense to live a bit beyond your means at the moment and borrow from your future, richer self. When it comes to saving money, many economists offer somewhat counterintuitive - and, dare I say, potentially irresponsible - advice: if you're young and on a solid career track, you might consider spending more and saving less right now. So, who's right in this financial royal rumble? The authors of self-help finance books or the stalwarts of traditional economic theory? While Choi doesn't always provide definitive answers, this debate might spark some ideas on how you can more effectively handle your finances. But, Choi says, the advice of popular finance thinkfluencers, who tend to concentrate on helping us overcome our flaws and foibles, might actually be more effective in some cases. And so, he says, classic economic theory may still provide a good overall guide for how to maximize your financial well-being. In a way, Choi says, behavioral economists like him try to help people overcome their shortcomings and achieve their financial goals as if they were the savvy creatures of old-school theory. Behavioral economics, which has pretty much taken over the field, emphasizes that people are quirky, often irrational, and prone to errors. Traditional economic models portray humans as hyper-rational, disciplined creatures, who always make optimal financial choices for themselves. That's because he's a behavioral economist who doesn't swallow the canon of old-school economics hook, line, and sinker. And, yes, Choi is an economist, but he may be a more impartial referee of this smackdown than you'd think.
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