In a world with so much conflicting advice on how to manage money, one of the most underrated skills is the ability to know which advice to take and which to ignore.
Here’s some simple advice on how to take advice. Anytime someone gives you advice on money or any other subject, ask yourself three questions.
Is this person a credible and accurate source of information?
Is this advice relevant to my current situation?
Am I the intended audience for this advice?
Let’s dive into each of these questions and discuss how you can use these questions to improve your ability to tell the difference between good advice and bad advice.
We are drowning in a sea of conflicting advice
There have never been more people giving personal finance advice than there are today.
There are over 17,000 personal finance blogs.
Dozens of YouTube channels are dedicated to personal finance, wracking up millions of views every day.
Many newspapers have columns dedicated to giving advice on money.
Entire publications, like the Wall Street Journal, exist to discuss the economy, investing, and other financial issues.
Celebrities and “financial guru’s” are always giving interviews where they are happy to dish out financial advice.
Don’t forget all of the people in your personal life that love to talk about all of the great money moves that they have made.
There is so much financial advice out there, and so much of that advice contradicts each other. One of the most underrated skills in 2020 is how to find reliable financial advice that is relevant to you and tune out the rest of the noise.
Let's review the three important questions you need to ask every time you receive advice about money.
Is this person a credible and accurate source of information?
Certain people are not credible sources of information that we shouldn’t ever listen to.
I’ve written in the past when discussing bad money advice, as a general life rule, don’t take advice from anyone who consistently tweets in all caps.
Rational people don’t need to shout to make their point. The evidence they cite should make their point for them.
People can give great advice on one subject and bad advice on another
There are a lot of financial “guru’s” and successful business people that are credible sources of information on specific subjects but not on others.
Take Dave Ramsey as an example.
When it comes to the subject of paying off debt, Dave is an expert.
He’s been helping people get out of debt for decades. You know Dave is a credible source of information on the subject of debt repayment because he can clearly articulate the exact steps someone needs to take to get out of debt.
He also talks in-depth about the psychological benefits of the snowball debt repayment strategy and how the power of “small wins” can help people stay the course.
When Dave Ramsey gives advice on how to get out of debt, he inspires confidence.
When it comes to the subject of investing, Dave often gives bad advice.
Dave’s bad investment advice is on full display in this video from his YouTube channel.
A caller asks Dave if she should be investing in index funds or mutual funds.
The caller (rightfully) points out that index funds have much lower fees than mutual funds.
Dave starts by telling him that investment fees aren’t a big deal, which is wrong. Morningstar has published research showing that investment fees are the number one proven predictor of future fund returns. The lower the fees, the better the expected future returns.
Then Dave goes on a rant about how anyone worried about investment fees is a liberal who “wants to focus on what’s wrong with America.” Which should be insulting to conservatives as it implies they don’t care about making smart investing decisions.
Dave Ramsey is a perfect example of a person who is a credible source of information on specific financial topics like paying off debt but not as reliable on other issues like investing.
My first piece of advice on taking financial advice; even if someone has proven to be correct in the past, it’s essential to verify any advice you receive before acting on it.
Is this advice relevant to my current situation?
Before you act on financial advice, take some time and think about how relevant that advice is to your current circumstances.
A well-meaning person can give advice that is not necessarily bad but ranks so low on your list of priorities that it becomes irrelevant.
The “latte factor” is a perfect example of this.
The latte factor was a term first coined by David Bach in his book The Automatic Millionaire.
The idea behind the latte factor is that seemingly small and routine purchases like buying a latte can add up to significant sums over time.
Bach argues that by cutting out these small purchases and automating the savings towards saving and investing, you can generate much more wealth over your lifetime.
Other well-known personalities have pushed this same concept.
Suze Orman has shamed Millennials for “pissing $1 million down the drain”.
Similarly, Shark Tank investor Kevin O’Leary told CNBC, “That is such a waste of money for something that costs 20 cents. I never buy a frape-latte-blah-blah-blah-woof-woof-woof.”
Lattes are (probably) not what is keeping you from saving money
First, let’s acknowledge the truth that, yes, cutting out lattes and frivolous spending can help you save more money.
However, cutting out those lattes is not going to save you as much money as the financial gurus will have you believe. In a previous article, I debunked Orman’s claim that you could become a millionaire if you stopped buying coffee.
If you want to save more money, don’t obsess over the small frivolous purchases, instead focus on your largest living expenses.
Specifically, I am referring to what I call “the big three” expenses.
Housing
Transportation
Food
These three expenses account for more than 60% of the average household budget. If you want to save more money, reducing your spending on the big three will have a far greater impact than cutting out your morning coffee run.
My second piece of advice on taking financial advice; Ask yourself if the advice you are receiving is relevant to you. Will acting on this advice make a significant impact on your life, or are there other actions you can take that will have a more substantial impact?
Am I the intended audience for this advice?
The final thing you need to keep in mind is that often when someone gives financial advice, they are speaking to a particular audience.
The clearest example of this comes from billionaire hedge fund manager, Ray Dalio, who famously insists that “cash is trash.”
Put in simple terms when Dalio says cash is trash, he means that investors would be better off investing rather than holding cash.
If we assume that Ray Dalio is right that cash is trash, does that mean you should take all of your cash and invest it?
Absolutely not.
When Ray Dalio says cash is trash, he is not speaking to you.
Ray Dalio runs a hedge fund, and his investors are ultra-high-net-worth individuals. These are people who have tens of millions of dollars in assets.
Financial advice that makes sense for wealthy people does not always make sense for ordinary people.
For someone with $10 million to invest, cash is probably trash.
For someone with $1,000 in their bank account, cash is everything.
My third piece of advice on how to take financial advice; there is rarely universal financial advice that makes sense for everyone. Personal finance is not a one size fits all issue. The reason it’s called “personal finance” is that you need to make financial decisions based on your circumstances. When someone is giving financial advice, ask yourself if you are the intended audience for this advice.
Simple advice on how to take advice
In a world drowning in a sea of conflicting financial advice, one of the most important skills is how to identify the advice that is most relevant for you.
Remember these simple tips on how to be better at taking advice.
Always question if the person giving advice is a credible source of information. Whether someone is reliable is not always a binary choice. There are plenty of people that provide great advice on a particular subject and lousy advice on another subject.
That is why it’s so essential to verify any advice you receive before acting on it.
Even if the person giving advice is credible and the advice they are offering is accurate, it’s important to ask yourself if the advice is relevant to your current situation. Ask yourself if you act on this advice, is it likely to make a significant impact on your life?
Finally, remember that people giving financial advice are often speaking to a particular audience. When I talk about personal finance, I am speaking to ordinary people. When a hedge fund manager is giving financial advice, they are likely talking to a very wealthy audience.
When someone is giving financial advice, think about who their attended audience is. If you are not part of that audience, the chances are that this advice is not meant for you.
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