Bogleheads on Investing with Sarah Newcomb – Episode 30

Rick Ferri: Welcome to Bogleheads on Investing, episode number 30. Today our special guest is Dr Sarah Newcom, a behavioral economist at Morningstar. Dr Newcom is well versed in consumer psychology, economic decision making, personal money management, and cognitive and social psychology.

Hi everyone my name is Rick Ferri and I’m the host of Bogleheads on Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy a 501c3 non-profit organization that can be found at bogelcenter.net. Today our special guest is Sarah Newcom. Dr. Newcom is a behavioral economist for Morningstar and the author of the book Loaded Money: Psychology and How to Get Ahead Without Leaving Your Values Behind. I think you’re really going to enjoy this podcast. It focuses on the fear of money and even though you may not have a fear of money, you know people who do. Today we’re going to find out why that is and how all people along the economic spectrum are overcoming their fears. So with no further ado let me introduce Sarah Newcomb. Welcome to the podcast, Sarah.

Sarah Newcomb: Thanks Rick, great to be here.

Rick Ferri: Well thank you for doing this. You’re an expert on psychology and money and today we’re going to be doing a deep dive into the psychology of people and how they approach money. Some people are afraid of money. Some people don’t want to deal with money, and this podcast is devoted to those people who do not have a good relationship with money even though they may have a lot of money. So Sarah, with that in mind, start the conversation if you will, with how you and your background got to the point where you studied this phenomena, the fear of money.

Sarah Newcomb: Yeah, for sure. Well, so one of my favorite definitions of an expert is someone who has made all the mistakes that can be made in a certain area. That’s how you get to be an expert and that is absolutely how I got to be an expert. And financial psychology is, you know I found myself in my late 20s with a degree in math. I love numbers. I will work on logic puzzles and number puzzles for an inordinate amount of time, and I have such a good time with it. And yet, I still with a degree in math could not get my finances together. And at that point in my life, having grown up in a situation with no or very little money and having to put myself through undergraduate school, starting at 24 really starting from zero in survival mode, I was having to wrestle with my finances. And you would think that if I could handle the fundamental theorem of calculus then I should have been able to get my finances together. And I couldn’t. I was still living pretty much hand-to-mouth, and I was married with a child, with a math degree, and I thought, “This cannot be about numbers.” It just is not about numbers, and I started to get really curious at that point.

I had been frustrated with money and with my, what I thought was just an inability to manage my own money. I  just thought of myself as “I’m not good with money” and that was part of my identity at that point. When I started to get curious I started to think, “Wait a minute, if I can handle calculus, I should be able to handle money. What is it that’s going on here? There’s something else going on.” So that curiosity, and it was a combination of curiosity, intellectual curiosity, but also just exhaustion. Because the reality is that when money is tight, life is stressful and I had spent my entire life up to that point always in a situation where money was tight, whether it was my parents’ finances or my own. The stress of not having enough had always been hanging over me and it’s exhausting. And I was tired of it. I was tired of being poor.

So at 28 I gave it a lot of thought and I decided to leverage my math degree and turn it into an intellectual exercise. I will learn how the pros do this. I am going to go to graduate school for personal financial planning. I will learn how to master money and I will get out of this poverty trap that I’m in. And so I did. I started going to Bentley for personal financial planning and started studying, you know tax and estate planning, and portfolio management, and all the basics. And I found a lot of it to be somewhat boring because I was hoping for more.

I was surprised because I thought that financial planning was going to be a lot more interesting. I thought I’d be picking stocks. I didn’t realize I’d be, you know, scanning people for their risk profile and then putting them in one of various buckets based on that; I thought there’d be more to it. But what really got me interested in thinking about money differently was when I took this elective. It was led by James Krebman. It was the first class of its kind that we know of and it was on psychology in financial planning. And it just struck me as interesting. I thought it would be good to understand how psychology connected to financial planning. And in that class, for the first time, we did not discuss interest rates or risk or asset allocation or the capital asset pricing model. We didn’t talk about any of that. We talked about classism, and we talked about cultural tensions. We talked about how each of us has a personal relationship with money that is largely inherited and usually unexamined and will then affect the decisions that we make with our money whether we are conscious of that or not.

And it was in that class that I started to really finally get power in my own relationship with money. because I started to examine and then challenge the deep beliefs I had about money that had been creating knee-jerk responses around earning and spending that I had not ever examined before. And so for me the light bulb went on and I realized my issues with managing money weren’t numeric, they were psychological. There were reasons why I hated and feared money. And that was causing all sorts of unconscious decisions that I was sabotaging myself financially.

Rick Ferri: Sarah, you mentioned the word inherited. You say you inherited these ideas. Could you expand on that a little bit?

Sarah Newcomb: Yeah. Well, so interestingly, another thing we talked about in this class was the three generation problem, the shirtsleeves to shirtsleeves in three generations, how money and wealth tends to be built up by one generation, spent by the next generation, and then the third generation is left to start over. Well my parents, each of them in their own right, happen to be that third generation. Their grandparents had great wealth on both sides of my family. Their parents inherited that wealth and squandered it, and they themselves were left to start over. And so both of my parents had complex relationships with money that involved a little bit of hostile envy of those who had it, for lack of a better term, and some really critical attitudes toward wealth and the wealthy. And without ever explicitly saying that, they looked down on the wealthy. I sure got that message in lots of little ways. My upbringing was anti-wealth. There was also a deep religious vein in my upbringing. Very deep religious being that glorified poverty and demonized money as being the root of all evil. And so there was a fear that I had inherited, that if I were to focus on making money and focus on financial security as a goal in my own life, that would mean that I was materialistic and greedy and therefore failed as a moral human being.

Rick Ferri: Wow, wow. How did you resolve this?

Sarah Newcomb: Well it wasn’t until I started to dig in and write my own financial story and start to uncover these things that helped me have that moment to realize how unhealthy my own attitudes toward money were, and how that– in the natural effect of that unhealthy relationship with money was a myriad of bad financial choices. 

Rick Ferri: I think you sum it up well in your book Loaded: Money, Psychology and How to Get Ahead Without Leaving Your Values Behind. You say in the introduction that you were brought up with the belief that either you cared about people or you cared about money. There was no in between.

Sarah Newcomb: Yeah and I’m–I don’t think I’m the only person that got that message. I think that’s a message that’s rampant out there. Take our service industries for example. People who love serving others, teachers, social workers, they have notoriously low salaries and so they’re asked to make this choice between serving people or serving themselves financially. Because that’s there, and because we moralize all these things, we justify our systems to ourselves. It’s become almost a badge of honor among some to not earn money, or not focus on money. And that was the environment that I grew up in, where the people that I knew and loved and respected had a deep disrespect for wealth and those who had it. And I think that it was a cultural defense mechanism. We tend to like to put down the other in order to feel okay about ourselves.

But this demonizing of wealth really caused me to fear earning and to fear money and to demonize money. There was this little distinction I needed to learn how to make in my mind where I had conflated money itself, which is an inanimate object that you can use to any purpose, but I had mistaken money itself and was blaming money itself for the choices that individual people make with their stores of money. I looked around and I saw inequality, lots of injustice, and money being used to exploit, capital being used to exploit, and it’s easy to blame money and the financial system because it’s almost easier to do that than to recognize, no there are human actors making choices, and it’s more productive to deal with the human actors and the social systems that we have set up as human actors. That’s where our frustration and our efforts at change are really actually productive.

But if we just blame money, which a lot of people do, they just decide not to have anything to do with money or the financial system. They just say, well money corrupts people and I don’t want to think about money. I don’t want to be the kind of person that focuses on money. I want to focus on something else. And it may be a very easy decision to make in the choice there in that moment. It relieves the psychological pressure in the moment and you feel better, but the problem with dismissing the world of money in that way is that you never learn how to use it to create the world you want. And so you are left with fewer resources to make the world you want. And I think that’s just a self-fulfilling prophecy. Then the only thing we have is a whole bunch of people who are materialistic, handling all the money. That’s not good for everybody either.

Rick Ferri: You took this course it was sort of a life-changing course as you’re going through the personal financial planner master’s program. Where did it go from there?

Sarah Newcomb: Once I was able to recognize the things in my own mind that had been tripping me up and keeping me from being comfortable with earning and managing money, then I was able to get my own finances under control. But like I said, I wasn’t really fascinated by the job of financial planner.  And a lot of people are. I’m not dismissing the job. I got really curious at that point about what are the ways, I know how I got in my own way, but could I look at research in general on consumer psychology and look at how are the ways that we tend to systematically get in our own way.

And you have to know, you have to remember, that this is 2007 – 2008 but I’m thinking about this, since behavioral finance wasn’t really a thing yet, and so this was just me, often my little bubble of my mind saying, “Look, I cannot be the only person who was smart and ambitious and motivated and bad with money because of unexamined beliefs that were getting in my own way.” And so I decided I wanted to pursue a doctorate where I combined economics and psychology. To really examine the psychological barriers to sound money management, and look at, do a survey of the literature of what do we know about how we tend to get in our own way when it comes to money. And then from there how we can step out of our own way and iron out our relationship with money so that we can be better with it. 

Rick Ferri: You had this epiphany and you started really working on this, and eventually you ended up at Morningstar. Could you tell us about that?

Sarah Newcomb: Yes. When I left academia with this degree in psychology and economics, where I had focused on the psychological barriers to sound money management, and specifically financial education, and a real passion to help other people like myself get out of their own way and get unstuck so that they could start using their resources to support the lives they want to live. So I went to Morningstar because Morningstar had a subsidiary, HelloWallet, which is a personal financial management application, and the goal there was to try to teach people who were pre-investors in the saving, or maybe even pre-saving stage of their financial life, how to make those choices. And focusing on trying to get people to think longer term, contribute to their savings, and learn how to invest.

And so my career from there has taken a different arc than I had originally thought it would. But I’m still very focused on the principles of personal financial planning, really demystifying the complex. Helping people realize that they can take control of their finances, but it’s not too complex for them to be good enough at it. And also recognizing the–not just the simple things about money management that they need to know in order to manage it well–but also how to maybe detect the things in their own mindset that could be tripping them up if they don’t examine those.

And so this blend of basic money management principles, combined with knowing yourself and that intersection between your mind and knowing money and how it works, is that sweet spot for being really good with money.

Rick Ferri: There are some studies that show that financial education, financial literacy doesn’t work.

Sarah Newcomb: There’s a lot of mixed results when it comes to the success of financial education programs, and some people will go so far as to say financial education doesn’t work.

Well I have to disagree with that because there it’s demonstrably true that when you know more about money you do make better decisions with your money. If learning about money didn’t help us make better decisions then we’d all be sunk. But what’s also true is that if you learn an abstract concept and you have no way to apply it and it’s not relevant to your life, you will forget it almost instantly.  And so most financial education transfers knowledge that is immediately forgotten and that’s the problem. It’s– you know, we’re teaching a math class, we’re not teaching a life skills class, and I think we need to be speaking to people’s minds, not to their wallets for one thing.

And talking about the financial decisions that matter to them, so just in time financial education has been shown to have some really good results, and financial advisors do just in time financial education because people come to you when they have a question, when they have a decision to make, they’re ready to learn because it’s relevant to them. So just in time financial education is great, but then where we get tripped up is that we start teaching the equations and we start hitting people with the fire hose of information that just makes them shut down, because they don’t need to know the calculus.

Rick Ferri: I completely agree that when someone is ready to learn that they learn a lot faster. What I have found true after 30 some odd years of doing this is that the amount of money you have doesn’t make you any more comfortable working with money. I don’t think that the level of wealth you have actually addresses the problems that people have.

Sarah Newcomb: No it definitely doesn’t, and I think that you know while mindset can contribute to whether or not you’re able to do the things that help you build wealth, there is definitely certain factors of mindset that help you build wealth and certain factors of mindset that will stand in your way of building wealth. But the other part of mindset that I think matters is just simply confidence.  Confidence with money; confidence with numbers. And just money is the most taboo topic of conversation in our culture, more than sex, more than death, more than politics. We do not like to talk specifically about money.

Rick Ferri: It is difficult for people.

Sarah Newcomb: The thing that’s coming to mind is this program that I listened to where a woman had gone and she wanted to interview people about money, and they were more than willing until she asked them to actually tell her how much they made, and then people got so offended. It’s just something that we don’t feel comfortable talking about, and it may be that we find it uncouth. It may be that we just don’t understand it well enough to feel confident talking about it. For whatever reason we are pretty clammed up when it comes to talking about money, and the result is that most of us end up with a pretty poor excuse for a financial education, and so we are left to try to figure all this stuff out on our own. And you can be incredibly educated, very smart, very successful, high earner, high net worth and still not understand the basics and mechanics of money.  And at that point it can be very embarrassing to even mention to someone, who are you going to tell, who are you going to ask for help.

Financial planners, I think, know very well that one of their biggest jobs is financial education. But I think that we really underestimate the level of financial illiteracy, even among very talented, smart, educated, and successful people.

Rick Ferri: Let me just tell you a story, and I’ve been a financial advisor for more than 30 years, and it amazes me when this happens, but it happens much more frequently than I would have ever expected.

By the way, as a financial advisor, there’s an old saying that if you really want to get to know somebody you either marry them or manage their money.  One of those, and you know people  tell you things, but I think one of the most interesting things from me in my career as a financial advisor is the amount of very wealthy people who say to me, “Do I have enough to retire? Do you think I have enough to retire?” or “Can I retire?”  And these are not people who don’t have a lot of money. I mean these people have five, ten million dollars or more. They’re spending maybe a hundred thousand dollars a year, maybe. And the first few times I heard this I was taken aback. “You know,” I would say to myself, “Can’t you do the math?”

I mean, if you’ve got 10 million dollars and only spending a hundred thousand dollars a year. I mean you know you’re gonna live a hundred years, if you had made no income, you know, spend all of that money. I do the math, and I said, “Well let’s look at it. You’ve got, you know, the X amount of money. Let’s divide it by how much you spend, and that’s how many years this thing will last.”  And they say to me, and I’m just amazed in this, but I hear it all the time, “God, never looked at it that way!  Yeah, I mean I really never thought about it that way!”  You know to me it’s like, wow really? You’ve never thought about it?

Sarah Newcomb: Like how did you not do this very simple equation? Well the reason they didn’t do it is because no one ever taught them how. And we know how bad we are understanding compound interest, right. We just don’t think that way. But I think we are really, really bad at mental math in general. And a lot of people also are just afraid of numbers. They just think they are not good with numbers. Once you give them an equation it’s like white noise. They just stop. Stop thinking. Stop listening. They don’t want to run the numbers.

But one thing that has been shown over and over is the typical person is pretty bad at translating a lump sum into an annuitized income. We’re really bad at knowing that relationship. You know what they need is a rule of thumb. And I know, rules of thumb. I heard on one of your previous podcasts, you were saying, I’m always, I’m always up against rules of thumb, people come into my office with rules of thumb and I need to like fix these rules of thumb in their head.

And the wrong rule of thumb can be very dangerous. But the right rule of thumb in the right circumstances can be an incredible cognitive device. And so the general idea of a rule of thumb, it’s a big idea you learned, it’s flexible knowledge you can use it in lots of different circumstances. It’s different from an equation because an equation you need to really know when do you use that formula, what are all the inputs, how do you do it exactly. The rule of thumb you can bring into lots of different scenarios. I’m trying to think of just what’s a really good simple rule of thumb.

Rick Ferri: Your age in bonds.

Sarah Newcomb: You know, something like that. It’s not exact. Obviously it’s not optimized. It’s a starting point, and it’s a conversation starter.

Rick Ferri: Yeah usually I start it by saying ignore it, but so it does come up, and when it does come up I say, well let’s talk about why that doesn’t apply to you. But at least it’s a starting point.

Sarah Newcomb: So a rule of thumb I love is the rule of 72, and the reason I love the rule of 72, you have to understand why we invest, and we invest because– really rough rule of thumb–but using the rule of 72 under three percent inflation costs double every 25 years. Your lifestyle will cost double what it does today in 25 years.

Rick Ferri: But before we go there, let’s just define what the rule of 72 is.

Sarah Newcomb: Yeah so the rule of 72 is this great little mathematical phenomena that if you take a growth rate or a shrinking rate, a growth rate or a diminishing rate, you divide 72 by the gross rate and that gives you the number of years that it will take for an amount to double. You know it really just comes down to there are a few simple concepts about how money works, that most people don’t learn well.

Rick Ferri: The way that we used to talk about the rule of 72 back in the good old days was that if you get a 10 percent return on your money compounded it will take 7.2 years to double. Or if you get a 7.2 percent return on your money it’ll take 10 years to double. So it’s like one or the other, but that was in the good old days when, of course, everything went up by 12 or 13 a year.

Sarah Newcomb: Right. I mean it’s flexible, right. So you can use the rule of 72 to teach the impact of inflation on the cost of living. 72 divided by 3 is about 24 point something, that means that prices double roughly every 25 years, every 24 point something years. And so why do we, in fact, why do we invest?  Because we want to beat inflation. We’re not because we want to beat our neighbor, or because we want to beat the market, but because we want our money to at the very least maintain its value, if not grow in value over time. That’s why you have to invest. That’s why saving alone doesn’t matter, is not enough, because the dollar’s value is constantly being eroded.

Rick Ferri: Of course if you believe there’s going to be a two percent inflation rate, which is the Federal Reserve target, then you take two into 72 and you’re at 36.

Sarah Newcomb: Thirty six, it’s not as bad.

Rick Ferri: Well it becomes really important if you want to retire early, say in your 50s, and, you know, what is the amount that I can withdraw off of my portfolio to live happily ever after? You do have to do this calculation to say, well you want to live off of 80,000 a year, now you’ll be needing $160,000 a year by the time you’re in your 80s to have the same spending. Now it is questionable whether or not people actually have the same spending when they’re in their 80s.

Sarah Newcomb: Right, and again the exactness of the math, I think when someone is hiring a financial advisor, a lot of times they want the advisor to do the exact math for them. But giving them the rule of thumb so they can understand the concept, so they can understand the general macro movements that are happening with their money I think really helps them get a sense of knowing what’s going on.

You can do the equations that get down to the nitty-gritty, but showing them the general relationship between time and money as it relates to cost of living, and also as it relates to compound interest, helps them understand why we’re doing what we’re doing, and why we’re translating something to a future value rather than the present value, why we care so much about inflation, why do these things matter. Because they really affect the bottom line of what you need to save in order to be prepared to maintain your lifestyle.

Rick Ferri: I’m going to circle back a little bit. You talked about having a mindset to build wealth. So this idea of how much you need to have a sustainable retirement is one part of it. And getting people to understand how inflation works, and how much money that is, and how much they need to save and so forth. What other mindsets do people need to build wealth?

Sarah Newcomb: We each tend to have a mental time horizon, so I’m not talking about your financial time horizon, just your mental time horizon.  When you think about your money, how long, how far into the future do you tend to think and plan. And a lot of people who are investing, especially long-term investors, they’re thinking 20 or 30 years ahead and that’s one of the reasons why they are long-term investors, because they have a long-term mindset. But many, many, many people don’t think more than a few months ahead. And then other people think just about a year ahead. When I did a survey, I’ve done several of these surveys, and what I find is that a good 70 percent of people are thinking less than 10 years ahead when they think about their money.

What I found was this almost a one-to-one relationship where the further ahead people were thinking when it came to money the more money they had accumulated, and this relationship was still significant when I controlled for age, for income, for financial education, and financial literacy. The point here was that the people who– there was like a breaking point, when people who thought 10 years or more ahead had ten times more saved.

Rick Ferri: Oh, it’s interesting. Wow!

Sarah Newcomb: Yeah. So, and what was really interesting was breaking the results up by income group. For example, I had a group of people who were making less than $25,000 a year, but those who were thinking more than 10 years ahead had several times their annual income already saved. Well so, but then the people who were thinking less than 10 years ahead needed to be making well into six figures before they were even saving significantly. And so what was really interesting is that, yes income matters, people, if you just look at savings by income, yes people who have higher income do save more, but if you break that down and you say, okay now within each income group the people who are thinking far into the future versus the shorter term thinkers, short-term thinkers don’t save as much. Long-term thinkers save significantly more in every income group, every income group, and so income matters but mindset matters more.

Rick Ferri: We talked about understanding how inflation can affect what you have. That’s a long-term outlook. I mean I just don’t think people who think about inflation and really work it into their equation for retirement are– have to be looking out more than 10 years. So sort of like they go together. 

Sarah Newsom: Yes, in order to be considering it in the first place, like I said, people who are investors are probably, especially long-term investors, are probably already long-term thinkers. Now let’s think about the case of a person who’s an investor but a short-term thinker. What kind of investor do you think that person is more likely to be?

Rick Ferri: A Robinhood investor.

Sarah Newcomb: They’re more likely to be speculating and trying to get rich fast. They’re going to take on more risk because there’s a link between our mental time horizon and our discount rate and our patience. And if you don’t — if you’re a short-term thinker, and I say this as someone who, I am naturally a very short-term thinker, one of the things I learned is that in the some of the root of my own mismanagement of money there is, yes there’s the emotional stuff around money, but I also am a very short-term thinker, and so short-term thinkers have special challenges when it comes to building wealth. And we have to be very, very deliberate and conscious about retraining our minds because having a short-term mindset leads to more impulsiveness, less patience, you’re going to be more likely to take on higher debt loads, less likely to save, more likely to overspend, and when you do invest you’re going to be more risk seeking, because you’re impatient about the returns.

And so I think that if there was one aspect of mindset that is really the wealth killer it’s short-term thinking. And we tend to be either short-term or long-term thinkers. But it’s not a trait level thing it’s more, it’s not character level, it’s more like they’re malleable. They’re not always easy to change but they are malleable. You can retrain them over time. And so if you’re a short-term thinker, training yourself to think longer and longer term is probably the best bottom line best thing you could do for yourself and your money,

Rick Ferri: Let me talk again about conversations that I have with clients when I run into this short-term thinking about investing mindset. I tend to talk with people about their careers at that point. I said, “You know, you are a physician or an engineer or a something, and it wasn’t as though you just got up this morning and decided I’m going to be a doctor, I’m going to be an engineer, or I’m going to be a lawyer, or whatever. You had to plan this and you had to do it for a long period of time. To go to undergrad, go to grad school, medical school, law school whatever it is that you did, and you wanted to get a job with the company where you were able to use your skills and do something great for the world, and so forth. And this was a very long term plan of yours that has been going on for years and years and years.” And generally people will agree with that. That’s correct. Then at that point I say, “Well, you know, investing is many ways the same way. It’s not like you could decide tomorrow you’re going to be a value investor or a growth investor, or maybe you’re going to get out of the market. That’s not how it works. You have to look at investing just like you look at your career. It takes years and decades to get to where it is you want to go.”  And I think that formulating, or trying to make a connection between how long it takes to build a career and to become successful in a career to investing in the markets, I think helps to stretch out that time frame that you’re speaking about.

Sarah Newcomb: Mm-hmm. That mental time — you set expectations that we’re not expecting that if you’re a good investor you’re going to have a thousand percent return in the first five years. You’re looking at a thousand percent return over a 25-year period. One study that was done showed that people, more impulsive people, actually the pain of waiting is greater. Time does actually seem to take longer, so impatient people literally pay a higher psychological cost for waiting than patient people.

And so to me I think it kind of throws a wrench in the works of the idea of us being irrational because actually what’s happening is there’s a mental cost benefit analysis going on and people who are short-term thinkers pay a higher cost for waiting, and so therefore their utility equation is totally different from a person who is patient and doesn’t feel pain, or as much pain, when needing to wait. So when you have a short-term thinking investor, an investor who has a short-term mindset, or is just a short-term thinker, you have to be prepared to deal with all the complications that come with the impulsiveness, the impatience, and the risk seeking that goes along with short-term thinking. And if you have a long-term thinker, those are the people who are just naturally inclined to be long-term value investors, and so they’re not going to give you any trouble. It’s the short-term thinkers who first have a hard time getting wealth in the first place, and then that when they get it they have a hard time holding on to it.

Rick Ferri: So I’ve seen some studies on this. Are women better at this than men?

Sarah Newcomb: Are women better at this than men? Okay, there are some studies that seem to suggest that women tend to have a longer term, tend to tend toward a longer term view. I don’t know that I’m really bought in yet. I haven’t seen enough to really prove to me that women and men are fundamentally different when it comes to investing. I do think that if there’s any research that I’ve seen that I find meaningful in this area, it’s again in the financial education research. What we know about financial literacy and gender is that women score lower on financial literacy tests than men do, globally. But there’s an interesting caveat in all these financial literacy questions they ask the big five, or the big three financial literacy questions which you can look up. They’re the same around the world. But the big five and the big three allow you to say “I don’t know” as an option for every question. And if you say “I don’t know” you will get the question wrong. So women have lower financial literacy scores but are more likely to say they don’t know.

Rick Ferri: Well I know that, men know it, I know the answer. I mean that’s clear. I mean a man is not going to say they don’t know. I mean you know we’re men!

Sarah Newcomb: But it’s interesting that culturally, this willingness to admit not knowing. And women are also, there’s some research that I’ve seen recently saying that some older women are more likely to seek out financial advisors and admit that they need help there. And so women may be better investors partly because of the cultural acceptability of being able to say “I don’t know, help me out”.

Rick Ferri: Well look, I’d like to get into your book a little bit, because you’ve got some really interesting information and Loaded: Money, Psychology and how to Get Ahead Without Leaving Your Values Behind and this goes with Maslow’s higher order of needs. You’ve taken this concept and you’ve broken it down to personal finance. I found it fascinating. Can you go through it with us?

Sarah Newcomb: Yeah. Most of what I’ve studied, and where my knowledge lies, is in the area of learning about money and financial education, financial literacy. And so often when in the programs that we have, that teach us about money, there is a common trope that we hear when it comes to budgeting and that is–you could probably finish this sentence for me–you have to know the difference between a want and?

Rick Ferri: A need.

Sarah Newcomb: A need, right. You can hear your grade school teacher saying,” Okay, to make good financial decisions you have to know the difference between a want and a need.” And I hear this all the time in financial education circles and it makes my skin crawl, because the reality is that if we really want to go down that logical route, then what we’re saying is if you don’t need it to survive you can’t justify spending money on it. And I think that’s absolutely bogus.

When you think about Maslow’s hierarchy, right, it is not Maslow’s hierarchy of wants, it’s Maslow’s hierarchy of needs. Yes they’re a hierarchy. Yes you care more about survival than you do about your emotional well-being, and yet there are times when we flip that hierarchy on its head. Anytime somebody texts while driving they’re putting their need for connection ahead of their need for safety. Anytime that somebody goes out, instead of putting gas in their car, they go out for beers with their friends, they’re putting their need for friendship and for fun ahead of their need for transportation. We will flip these all the time and the fact is that they’re all needs.

What really revolutionized money management, personal money management, for me was realizing that all of the things that we do with our money, whether it’s paying our mortgage or buying a pack of stickers at a checkout line for our kid, and even the impulsive decisions, every one of them can be traced back to an attempt to meet one of the fundamental human needs, and all of those can be found on Maslow’s hierarchy.

So yes, I can survive without friendship and love and meaning and spiritual fulfillment. I can survive without those things. Do I want to? No, so I don’t think we should make money management about only budgeting for the things that are down at the bottom of Maslow’s hierarchy. What that is basically doing is turning budgeting into an exercise in how we’re going to feel bad, here’s how I’m going to deprive myself…

Rick Ferri: How I will become depressed–

Sarah Newcomb: …of the things that I really want in my life, right? That’s why budgeting feels like a diet. That’s why people hate it. That’s why people make a budget and then can’t stick to it. Because they’re budgeting based on this definition of need, that if you don’t need it to survive, you can’t justify spending money on it. And I think that makes for very unhappy people, very unfulfilling lives, and we will not stick to a budget. Like yes, the numbers need to work, but your life needs to work too.

And so the goal I think of healthy money management is not recognizing the difference between a want and a need. I think that’s the wrong framework. We need to recognize the difference between a need. And a need can be found in Maslow’s hierarchy. The needs are all human needs, they’re universal human needs. We all need to matter, we all need to belong, we all need connection and intimacy, and solitude and shelter, and food and clothing. But we need all of these things in order to thrive as human beings, and if we only meet our physical needs at the expense of our emotional and social and spiritual needs, we will be unfulfilled people.

And so we don’t want to plan our financial lives in such a way that sets us up to be unfulfilled people. That’s not the point of money management that makes the numbers work at the expense of yourself. But instead what we want is we want to be more fully conscious when we plan our budget to say how will I meet all of my needs, my need for connection, my need for social life, my need for fun, my need for belonging, and my need for food, shelter, and clothing within the confines of my available resources.

And yes, it’s a harder problem to solve, but you’re going to get a better answer on the other side. You’ll end up with a budget that you can keep, and not only a budget that you can keep, but one that allows you to enjoy your life now and in the future. It’s not an exercise in depriving yourself now so that you can enjoy your life in the future. It’s how do you live the most fulfilling life now and in the future. And that’s why I think we need to recognize that Maslow’s hierarchy tells us all of the things that a human needs — we need self-actualization as well as food, sheltering, clothing — and so if our budgets aren’t allowing us to be driving for and achieving self-actualization, now that’s not the right budget for us.

Rick Ferri: That’s great, good stuff. You know it’s funny, I talk with a lot of retirees and they say well, you know things get tight and the market goes down, we just won’t spend as much money, we just won’t go on vacation anymore or go out to eat anymore or get a nice bottle of wine anymore. And I said “Well, I don’t know if that’s true or not.” But what you’re saying is it’s not because you’ll become immediately depressed by not doing those.

Sarah Newcomb: Right, and the thing that’s really interesting is once you start to work with your budget, and I make some suggestions in the book of how to do a budgeting exercise, where you’re reducing expenses while increasing life satisfaction. And that’s the real beauty of it, is being able to come up with a budget that meets all of your needs so that you’re really satisfied and thriving without sabotaging your ability of– like, one of your needs is long-term solvency. So you can’t meet your need for long-term solvency at the expense of short-term happiness, but you also can’t have short-term happiness at the expense of long-term solvency. You have to find solutions where both needs get met. And it is possible. It just takes some practice and a bit of a deeper, different kind of thinking than we’re used to when we just make a list of expenses and make a list of income and expenses.

Rick Ferri: That’s great. The name of the book is called Loaded: Money, Psychology and How to Get Ahead Without Leaving Your Values Behind. Sorry, I got a couple more questions for you, and I run into this all the time, and it is with people who just can’t stop working, they just continue to feel like they have to work, even though they know they have enough money, even though they know they can retire. They still put in 50 – 60 hours a week. They do want to cut back, but they can’t cut back. They just feel like if they cut back, the whole world is going to collapse. They’re going to lose all their money. What first of all, what is this called?

Sarah Newcomb: I like to call them “the worried wealthy.”

Rick Ferri: Okay. and how do you solve this problem? Because I run into it quite often.

Sarah Newcomb:  I worked on a framework a year or so back on a financial mindset and on what I was really trying to drive at is a model that can sort of place people and how healthy is your financial mindset.  And there were a couple of key factors that contributed to financial well-being. First of all you’ve got to understand that there’s two axes to financial well-being. Economic, so yes, you have to have assets. But there’s also the emotional aspect of financial well-being, and so if you think about this as an xy axis, you can have people that are very high on the economic part, but low on emotional well-being, so they’re stressed, they’re worried, they’re anxious, they feel helpless, but they have plenty of assets. And you can also have people on the other extreme that are feeling completely satisfied and happy and carefree, but they have no assets at all. And both of those extremes are unhealthy. One because you’re at risk of complete catastrophic financial failure if you have no solvency and you’re carefree about it; and two, if you have plenty of economic stability but no life satisfaction, what good is your money anyway. 

So the goal of wealth is not to be wealthy. The goal of wealth is to be happy. I mean I love Brian Portnoy’s “Funded Contentment,” that’s what it’s all about. So if you don’t have the contentment even once you have the funding there’s something wrong. So I like to refer to this as” the worried wealthy.”  These are people who would be high on the economic scale, low on the well-being scale, and the drivers that I have found are really linked to the emotional side of financial well-being are two things. Number one is locus of control, and that’s just a scientific way of saying where do you believe the control in your life is centered. So people who have an internal locus of control are the people who say I create my financial destiny. I’m in the driver’s seat. I can make it happen. I’m the one in control. People with an external locus of control believe that forces outside themselves control their financial future and well-being.

Imagine a graph where you’ve got people grouped in different income groups from like 25,000 a year all the way up to you know 150,000 plus a year, and you just ask them which statement do you most agree with: Either I control my financial destiny, or I have very little control over my financial future. 

So I asked people to tell me which statement they most agreed with, and then I looked at their emotional well-being with respect to money. So how often were they feeling stressed, angry, sad, or helpless. How often were they feeling joy, peace, satisfaction and pride with respect to their money.  And what I found was across the board people who feel that they are in control of their financial future were generally feeling pretty good about their finances regardless of which income group they were in. They felt more positive than negative emotions with respect to money. But regardless of income, people who felt that external forces were really in the driver’s seat of their financial life, it didn’t matter how much money they were making, they were feeling more stress than peace, more depression than satisfaction, more helplessness than pride etc etc.

Rick Ferri: And this had nothing to do with how much wealth they actually had.

Sarah Newcomb: Yeah this was just whether or not they felt they were in the driver’s seat of their own financial future or not. So this sense of being able to have a sense of personal control over your own financial life, and you see this in entrepreneurs. They can make millions, lose millions, and bounce back and what do they say, “I did it once. I can do it again.” And they’re right. They believe they can go and do it again, because that’s an internal locus of control, whereas the people who are “the worried wealthy” they feel out of control, they’re “what if ” thinking there are so many “what-ifs” that go on in their mind, and the thing is, the things we can scare ourselves with, there’s no amount of money that can make you feel safe if you’re going to “what if” yourself all the time.

Rick Ferri: Interesting. I speak with a lot of physicians, and there’s a lot of them are always worried about medicare repayment and the health of the medical industry, and they’re worried so much that it really kind of surprises me. But now the way you explain it–

Sarah Newcomb: Their attention, yeah their attention is on what they can’t control.

Rick Ferri: That’s correct. Yeah, I see.

Sarah Newcomb: Macro trends that they can’t control, right.  And if your attention is focused on the things you can’t control you will feel worried. But if your attention is focused on the things that you can control you’ll feel more peaceful. Or alternately, if you can do what Jim Grubman calls turning the “what if” into a “so what” where you say “Okay, what if it really did all go down the toilet, what would you do then? Let’s talk about that. What would we do?” And sometimes getting people to take that extra step past the big nebulous catastrophe in their mind to “Okay let’s assume that happened, let’s assume it all went away. What would you do? How would you rebuild?  Where would you go?” And one of the things that I think is really comforting for people when they do this exercise, is to recognize that the thing that really matters to them is that even if they lost all their money the people who loved them would still love them. I know that that sounds really simplistic, but it’s so real. So much what we’re really afraid of losing is our sense of belonging.

Rick Ferri: Let me ask one last question and wrap it up today. We’re in the middle of Covid. We have a lot of young people who are just getting started who have lost their job, can’t find jobs or they fear losing their job. They fear that the economy is not coming back. But they’re out there. They’re working at this. What kind of advice would you give to them?

Sarah Newvomb: I would say honestly if you’re looking at a 40 –  50 year time horizon you are looking at being on the cusp of an entirely new economy, how is that not extremely exciting? A lot of uncertainty but also very exciting. And I think it’s as hard as it is to trust your gut when you’re young, I think, really if you’re looking on, if you’re on the job market or you’re thinking about what do you want to do for a career or if you’re just starting investing, this is an interesting time. There’s a lot that we don’t know right now, but we do know a few things on the very macro level. We know the economy of 30 years from now must be lower carbon, so investment decisions and career decisions and real estate purchase decisions and things like that, I mean we’re at a point, a moment in history where there are a couple things that we can say we know about the future economy. And I think that makes it a very exciting time to be a long-term investor, whether you’re investing in a career or assets.

But in terms of the day-to-day what do I do to make ends meet right now? I think that we need to relax the pressure we put on ourselves to be hugely independent at all times, and right now is a time when people are coming together and family groups are helping support each other and friend groups are coming together to support each other.  And I think that the economics of communities is going to become more and more something that we hear about and think about, so I would say look to your community your social and economic network and be looking for how you can contribute to that and make that both efficient but also satisfying because I think it’s our small communities and tribes that are going to see us through this really weird time.

Rick Ferri: Well Sarah thank you for contributing to the Bogleheads community with your wisdom and your experience. Been a really interesting discussion and I greatly appreciate you being on the show.

Sarah Newcomb: Thank you so much.

Rick Ferri: This concludes episode 30 of Bogleheads on Investing. I’m your host Rick Ferri. Join us each month to hear a new special guest. In the meantime visit bogleheads.org and the Bogleheads wiki. Participate in the forum and help others find the forum. Thanks for listening.