Arguments in the world of finance often revolve around whether to take action A or action B with each having a unique set of risks and rewards that can be quantified by rates of return and standard deviation measures, respectively. As an example, you can purchase investment A that will return an estimated 8% annually and will have a standard deviation of 14%. Investment B has an estimated annual return of 7% and a standard deviation of 10%. Which should you choose?
Herein lies the difference between finance and personal finance as these alternatives have no context whatsoever. What if you're in debt? How about if you're 85 years old? What would be the decision if you didn't have an emergency fund? This is the fundamental problem in arguments in personal finance. Often, people fail to add the personal part of the equation that gives us the necessary context to make better decisions.
The questions above are relatively easy to answer. If you're in debt, you should choose option C - paying off your credit cards. If you're 85 years old, you could choose either investment to round out your portfolio. If you don't have an emergency fund, you should choose option D - cash equivalents. But what if it's a little more complicated than this? What about paying off your mortgage early?
And this is one of the great debates in personal finance. If you speak to an accountant, corporate financier, or other numbers nerd, you'll get the finance answer - leverage your investments by keeping a mortgage as long as possible. If you speak to a personal finance professional, you'll get a different answer - eliminate the mortgage as soon as possible after making sure you have (1) no other debts, (2) sufficient cash reserves, and (3) maxed out tax favored retirement savings opportunities, among other things.
In this example, the finance experts will tell you to do the math and whatever the math comes to, do it. The personal finance experts will ask for more information and weigh the decision in light of your overall financial position. The difference is about the size of the Grand Canyon. On the one hand, a finance expert will say go this direction, turning a blind eye to the rest of the picture. On the other hand, a personal finance expert will look around, survey the landscape, and arrive at a decision.
You tell me, which would you rather have? A blind walk from the edge of the Grand Canyon, or perhaps, one with a little more vision.
Principle: Personal finance employs the math of finance, but is not subservient to its calculations.
