Your book’s title seems ambitious. How did you select this topic, and what was your motivation for writing the book?Intelligent money management is fairly straightforward: We settle on our goals, take on debt cautiously, save diligently, hold down investment costs, manage taxes, diversify broadly, and buy insurance against life’s major financial risks. Yet, despite the relative simplicity, many folks make major financial mistakes, they worry constantly about money, and they don’t get all that much happiness from the dollars they spend. That raises an obvious question: What does it take to have a happy, successful financial life? I’ve thought about this question a lot over the past three decades—and How to Think About Money is the result.
Do people treat money in a more complicated way than necessary? If so, why?We all like to think we’re rational when handling money, but there’s ample evidence that suggests otherwise. We struggle to save enough. We become unnerved when the stock market goes down. We think we can outperform the market averages. We buy possessions not just for their utility, but also because of how they make us feel and what statement they make about us to the rest of the world. This maelstrom of greed and fear leads us to spend too much, earn lackluster investment results, and end up with an unnecessarily messy financial life.
Part of the blame lies with the hardwired instincts we inherited from our hunter-gatherer ancestors. Our nomadic ancestors were focused on surviving until tomorrow. We, on the other hand, have to focus on saving for a retirement that might be 40 years away. Not surprisingly, this isn’t something that comes naturally to us.
Part of the blame, however, also lies with financial firms. Wall Street feeds the fantasy that investors can beat the market, because efforts to beat the market are highly profitable—for Wall Street. You can charge a lot more for an actively managed fund than for an index fund.
You express some skepticism about Wall Street, yet you make a compelling case for investing in the stock market. Why should we continue to have faith in the U.S. and global economies?As long as the global economy keeps growing, stocks should be a decent long-run investment. But make no mistake: Returns over the coming years will likely be lower than historical averages, partly because the U.S. economy will almost certainly grow more slowly and partly because valuations are richer.
Over the past 50 calendar years, we’ve had annual inflation-adjusted economic growth of 2.9%, with half coming from rising productivity and half from increasing the number of workers. But with the workforce projected to grow at just 0.5% a year, well below the 1.5% average over the past 50 years, it’s more reasonable to expect 2% average annual economic growth. That, in turn, might mean 2% annual growth in corporate earnings. Meanwhile, dividend yields today are closer to 2%, versus the almost 3% they were 50 years ago. Add that 2% dividend yield to the 2% expected growth in corporate earnings, and you might be looking at long-run stock returns that are perhaps 4 percentage points a year above inflation. That’s far below the historical average of 7 percentage points.
How are people better served by thinking about money as a tool, rather than as a trophy?As I argue in my book, managing money shouldn’t be about proving how clever we are, beating the market, or becoming the richest family in town. Instead, it’s about putting aside money today so we can spend it tomorrow on important goals like purchasing a house, putting kids through college, and retiring in comfort. These specific goals fall within a larger, overriding objective: We want to have enough money to lead the life that we want.
Each of us gets just one shot at making life’s financial journey—and we shouldn’t do anything that could potentially derail that journey. When the issue is framed that way, it becomes much clearer how we should handle our money. We should eschew unnecessary risk and instead pursue strategies that have a high likelihood of success. That means diversifying broadly, minimizing investment costs and taxes, and purchasing insurance against major financial threats.
You write that income doesn’t appear to affect happiness after it reaches roughly $75,000. How was that figure computed?The $75,000 comes from a study by academics Daniel Kahneman and Angus Deaton and was based on Gallup Organization survey data. What’s shocking is how low it is. A key implication is that if we want a happier financial life, we shouldn’t focus on earning more. Instead, we should think hard about how best to use the money we already have. Think about all the dollars you’ve spent in 2016, especially discretionary spending on items like dinners out, travel, and possessions you wanted but didn’t really need. Which of these expenditures brought you the greatest pleasure—and which purchases made little or no difference to your happiness?
How can saving and investing lead to freedom and happiness?I believe there are three things money can do for us. First, having some savings, coupled with a reasonable grasp of financial basics, can lead us to worry less about money—and that’s a huge benefit. Second, we can use our money to create special times with friends and family, which research suggests will deliver a big boost to happiness. Third, money can allow us to spend our days doing what we love. We talk about retirement as though it’s the great financial prize. But in truth, most of us get a lot of satisfaction from work—as long as it’s work we’re passionate about. If we’re smart about managing money, we can achieve true financial freedom. In my book, that means spending our days focused on activities that we think are interesting and important.
Opinions expressed by Mr. Clements are not necessarily those of Vanguard.