Who gives the best retirement advice? Suze Orman and Dave Ramsey or economists?

And in those and other books of that ilk, the authors write about the importance of starting to save immediately, the magic of compound interest, and the need to build an emergency fund. In fact, these authors advise readers to continue saving at a high rate even after an adequate emergency savings fund has been established.

Consider his book, “Money: Master the Game”, Tony Robbins wrote: “Whatever that [savings percentage] number is, you’ve got to stick to it. In good times and bad. No matter what. Why? Because the laws of compounding punish even one missed contribution.”

But this advice about not just savings rates, but also asset allocation, using a fixed versus adjustable-rate mortgage, managing nonmortgage debt and spending in retirement “often deviates from economists’ advice,” according to James Choi, a Yale University professor, who recently reviewed 50 personal finance books and compared it to the prescriptions of normative economic models.

Read: Popular Personal Financial Advice versus the Professors.

To be fair, popular financial advice may be more practically useful to the ordinary individual, according to Choi. In fact, the authors of such books get two things right relative to economic theory, according to Choi: One, the actions they recommend are often easily computable by ordinary individuals, and two, the advice offered takes into account difficulties individuals have in executing a financial plan due to, say, limited motivation or emotional reactions to circumstances. 

But, he also noted, “the advice deviates from normative economic theory because of fallacies.”

And, as a result, there’s a considerable gap between theory and practice. 

Consider what the professors say versus what the popular personal finance authors have to say about saving for retirement, asset allocation, and retirement income. 

How much to save for retirement 

When it comes to saving money, economists favor what the life-cycle hypothesis recommends: “It says when you’re young and your income is low relative to your lifetime income, you should not be saving all that much because you want to have a relatively consistent path of consumption over time,” said Choi in an interview. “Save relatively very little when you’re young, save a lot when you’re mid-age, and then draw down as you enter your retirement years.” 

But that’s not what the authors of personal finance books recommend. “The popular authors have a pretty different conception,” said Choi. 

Their advice: Save 10% to 15% of income regardless of age and circumstances during your working years. “They think you should be smoothing out your savings rate rather than your consumption rate,” said Choi. “You have to establish the discipline. You have to become the type of person who saves and just saves consistently. And then the power of compound interest is going to make everyone a millionaire if only they can forgo a latte a day.” 

There’s truth to that, but the life-cycle model takes all that into account, Choi said. “So even with the power of compound interest, you shouldn’t be saving so much when you’re young,” he said. 

In fact, the optimal savings rate, according to Choi, is whatever the difference happens to be between income and optimal consumption. And not surprisingly, he also notes that the common policy of making the default retirement savings plan contribution rate not dependent on age is suboptimal. 

Read: Many young people shouldn’t save for retirement, says research based on a Nobel Prize–winning theory.  

What gives? Why the difference between theory and practice? Is it because personal finance authors don’t understand economics? Not necessarily, said Choi. It’s more a function of focus. Economists, he said, are focused on utility. And utility comes from consuming. “You want to maximize the total happiness you get from consuming over time,” he said. “And the popular authors don’t really think that way at all. It’s just not part of their paradigm.” 

Their paradigm is more that saving is a virtue; that it’s important to establish saving consistently as a discipline and take advantage of the power of compound interest. And quite frankly, notes Choi, the need to create the discipline of saving is “almost always missing from economic models of optimal saving—a potentially important oversight.” 

What’s the right asset allocation? 

Personal finance authors and economists land in the same place when it comes to asset allocation but for different reasons. For instance, the investment horizon is of paramount concern for personal financial authors. The longer your investment horizon, they say, the greater your allocation to equities could be. In fact, some of the authors recommend that investors use the “percent of the portfolio in stocks should be 100 minus your age” rule. (Think target-date funds.)  

What’s more, the personal finance authors are fond of suggesting that stocks get less risky over time.  

For economists, however, it’s not the investment horizon that dictates asset allocation; rather future income is the dominant consideration. 

“For someone who is young, who has a lot of labor income remaining in their future, they can afford to take a lot of risks in their financial portfolio,” he said. “Then they need to scale back that risk when they get older and they don’t have that much labor income remaining in their life, in which case they need to be more conservative in their financial portfolio because they don’t have that labor income buffer.” 

Thus, personal finance authors and economists might suggest that a 20-something allocates 80% of their portfolio in stocks and 20% in bonds. The authors would suggest that asset allocation given the multi-decade time horizon, while the economists would suggest that asset allocation because the 20-something needs to incorporate their future income, their human capital, into the investment portfolio. The future income represents the fixed income allocation and stocks would then represent the larger share of the investment portfolio. 

“For most of us, our labor income is not hugely tied to the stock market and you can think of it as a pretty safe asset,” said Choi. 

Managing longevity risk: 4% rule vs. an annuity 

When it comes to generating income in retirement and managing the risk of outliving assets, the personal finance authors recommend an entirely different approach from economists. The economists recommend either fully annuitizing one’s wealth in retirement or, if not, an aggressive drawdown strategy. The personal finance authors, meanwhile, advise against annuitizing and instead recommend a fixed drawdown rate, say 4% of assets adjusted for inflation each year. 

“Annuitizing just isn’t on their radar screen,” said Choi.  

The personal finance authors note, for instance, that annuities don’t mitigate the risk of inflation, or that annuity contract owners might die early, or that annuity contract owners give up control of their money. “But for economists, the dominant consideration is that you can’t take it (your nest egg) with you,” said Choi. “Once you’re dead, you can’t take it with you. Once you’re dead, that money is no good to you.” 

The great thing about life annuities, he said, is that the contract owners who die early subsidize the people who will live a long time. “The people who are still alive are the ones who need the money, not the people who’ve already died,” Choi said. “And if you die young, the financial losses are the least of your worries.” 

For people who want to leave a bequest to their heirs, Choi suggests carving out a portion of one’s assets for that and annuitizing the rest. That way you’re de-risking your portfolio. “But people just don’t seem to think that way,” he said. 

You’re putting a lot of risk on your heirs when you don’t annuitize and say anything that’s left over will go to them, according to Choi. Why so? Well, if you live for a long time, then your heir’s inheritance is going to be relatively small. And if you die too soon, their inheritance is going to be relatively large. 

Drawing down assets

As for drawing down assets, the personal finance authors recommend spending to keep one’s real level of wealth roughly constant in retirement. But economists take an entirely different perspective. “You can’t take the money with you,” he said. “Why’d you save all this money over your lifetime? It’s so that you can spend it down when you’re retired and when you’re on your deathbed, at least in the economist framework, you want to spend the last penny that you got and then die a second after that.” 

But the popular authors seem to be oriented around “preserving one’s principle indefinitely,” said Choi. 

Of course, dying broke is easier said than done. No one knows their date of death. “The economist’s solution is to buy an annuity,” he said. “Then you don’t have to worry about this stuff.” 

If you’re not going to buy an annuity, then the economic model says you should be “dissaving” over time, said Choi. “You should be worth less financially when you’re 85 years old than when you’re 65 years old.” That would mean not just withdrawing 4% per year but increasing that percentage over time. “If you’re 85 and you’re still drawing down only 4%, you could probably afford to spend more at that point… You should be spending more today because tomorrow may never come.”

 Yes, he admits, that makes people nervous. “They’re nervous that they are going to run out of money,” he said. “But if you’re nervous you’re going to run out of money, buy an annuity.” 

The right book? 

Does Choi recommend that savers and investors read any of the books he reviewed? Was one better than all the rest? In short, the answer was no. In fact, he “fundamentally disagreed” with the advice being delivered in every single book. 

Choi did, however, say that he teaches a personal finance course at Yale University. And in that course, he uses Personal Finance for Dummies by Eric Tyson as the textbook. “Despite the title I find it to be a surprisingly good book,” he said. There is, of course, plenty in the book that he disagrees with. But, he said, there’s much in the book that’s “fairly reasonable.”