Tess Vigeland: One of my pet peeves in the personal finance world is this notion that there is one right way to manage and think about your money. For example: Using credit cards is always bad! Well, no it's not. If it works for you, great. If it doesn't, that's OK too. Or how about this one that's sprung up since the housing crisis: Nobody should own! Everybody should rent! Well, no. It's more complex than that.
So I like it when someone in the personal finance space dares to sacrifice our sacred cows. We're going to talk in a moment with Ramit Sethi, best-selling author of "I Will Teach You to Be Rich". And we're going to address what we'll call the "Latte Factor." But first, a clip from a commentary he did for us a few months ago.
Ramit Sethi: Have you ever noticed that personal finance experts love lecturing Americans about what they can't do with their money? They say things like: "Stop spending money on lattes!" "You can't afford those jeans." "Eating out? You should cook at home every night -- duh."
The only problem is, these tips haven't worked for the last 50 years.
Vigeland: Duh! Ramit joins us now to delve into this, perhaps, a little more deeply. Welcome to the program!
Sethi: Thanks for having me.
Vigeland: So, this is a topic that I think tends to come up at this time of year, particularly around New Year's, when you start hearing all of the various ways that you can save money, bring your budget down. Why does that not work?
Sethi: It's a classic mistake that experts make. They sit in their rooms, they come up with an idea that sounds logical -- keep a budget, don't spend money on lattes. And they write it up in a book and they go on a radio or their go on the Internet and they say it. The problem is they never actually stop to test it and see if people actually follow their advice.
Vigeland: And your argument is that they don't.
Sethi: They don't. We know for a fact that they don't. People do not keep budgets. When you tell them to stop spending money on lattes, simply look at the last 20 years -- is it working? No! So if somebody comes and says, "No no no. You can't do that with your money!" What's the first thing I say to them?
Vigeland: Yes, yes, yes I can! It's my money!
Sethi: Exactly, it's my money and I'm not gonna listen to what this person is telling me I can't do.
Vigeland: But I think what always strikes people is the math. And you'll read these stories where if you cut out that latte for one week, yeah, it's only gonna save you five bucks. But for your lifetime, it's gonna cost you $20 million!!! Right?
Vigeland: That's pretty stark.
Sethi: It's a marketing hook that people use. I could create 50 marketing hooks right now. But that's not the way people really work. We operate on a basis of psychology, right, our immediate needs and wants versus long-term wants and needs. And there are ways to balance both of those. And that's really what we're talking about. When you have someone coming in and saying you can't do XYZ, the first thing we do is a psychological term called "reacantance." And that's what happens when we say someone's trying to take away what I feel is my right, and I instantly put up my defenses.
Instead, what about doing something different? Why don't we talk about things like, "Look, automate your money, so that part of it is automatically going into your savings. And if you do that, you could spend as much money as you want on lattes." Or focus on the big wins in life. How come we're not talking about negotiating your salary? That's a $5,000-$10,000 win right there. That's worth more than a million dollars over your career. Or improving your credit. By the way, the difference between someone who goes to buy a house with poor credit and excellent credit -- that's over $100,000. So, there are big wins in our life and if we just get these five to six big wins done, we don't have to worry about the little things, like lattes or if I'm buying a medium or small-sized Coke when I eat out.
Vigeland: But how can cutting back on your spending be a bad thing?
Sethi: There's a cost for everything. We are what's called "cognitive misers." We have limited cognition, limited willpower.
Vigeland: I'm not a miser!
Sethi: We are all misers Tess! I'm a cognitive miser. You know how you know this? Because you wake up in the morning and there's 50 things you can do with your money. You could pay off that debt, you could buy those shoes, you could go out to drinks -- and faced with these 50 decisions, what do we do?
Vigeland: We're gonna spend some money.
Sethi: We're gonna do the same thing we've always done. And so what a lot of the latest psychological research shows is that if we can narrow these choices down, we can actually make better decisions. And we know this intuitively: Think about it, when you go to work and you have 50 things on your to-do list, you end up doing none of 'em. If you have three, you're gonna knock those out. So lattes, there's a cost to that. You're using part of your treasured willpower. Would you rather spend that limited willpower on something like a $3 expenditure? Or would it rather be spent on something like earning more money, automating your money? Or you're gonna buy something, should you buy it on your credit card, should you not? Et cetera. Those are worthy of our willpower. A $2 purchase is not important in the grand scheme of things.
Vigeland: Ramit Sethi joining us in the studio here in Los Angeles. Thanks so much for coming in.
Sethi: Thank you.