How the Shifting Economy Changes (and Doesn’t Change) Personal Finance Advice

When I first started writing The Simple Dollar, it was quite easy to find savings accounts that offered interest rates as high as 5%. Even more amazing, banks offered certificates of deposit (CDs) that had rates that approached (or sometimes crossed) 6%.

In that environment, there were a lot of pieces of personal finance advice that made sense that might not make sense now.

I’ll give you a clear example: CD ladders. I wrote about the idea of CD ladders almost four years ago, but the concept is simple to explain. Let’s say that a bank is selling 3-month CDs at 5%.

On January 1, you buy a CD.
On February 1, you buy a second CD.
On March 1, you buy a third CD.
On April 1, the CD you bought in January matures. You use the proceeds from that to buy another CD.
… and so on.

After the first three months, you can just use the proceeds to buy another CD. This was a great thing to do with a large emergency fund by parking a month of living expenses in each CD because if you have a CD maturing each month that holds a month’s worth of living expenses, you can live on a chain of such CDs if you need to.

Here’s the thing, though. Compared to an ordinary savings account, a CD has some benefits (a higher interest rate) and some drawbacks (you essentially can’t touch it until it matures, meaning your money is locked away). In order for the benefits to outweigh the drawbacks, the interest rate on a CD has to be notably higher than the interest rate on a savings account.

In 2007, you could often find interest rates that were 1% or even 1.5% higher on a CD than on a savings account. That sort of gap made the difference worthwhile and made buying CDs make sense.

Flash forward to today. Rarely can you find a CD that’s more than 0.25% higher than what you can get in a savings account. That gap makes CDs a lot less appealing because of the flexibility you have to give up to get them. Thus, the changing economy has changed some sensible planning for cash savings.

There are many examples of these types of changes, such as credit card arbitrage, individual company investing, and so on. The more specific the investment or financial choice you’re discussing, the more likely it is that the advice you’re given will change with time and the economic tides.

If that’s the case, what good is such advice? Advice that describes very specific investments are good for people who want specific directions to follow, but it’s important to note that such advice becomes dated very quickly.

A much better approach is to understand the principles behind what you’re doing so that you don’t need the specific advice. How much is the drawback on that CD really worth to you? I price it at around 1% – the lack of liquidity really is a drawback. So, if a CD beats my savings rate by 1% or more, I’ll put some of my savings into a CD. Otherwise, I’ll let it be. This rule works when the economy is doing well and when the economy is doing poorly.

The best personal finance advice works no matter what the economy is doing. Spend less than you earn. Invest in a diversity of things, including yourself. Avoid debt unless you have a guaranteed return that greatly exceeds the interest you’ll pay on that debt. Save for purchases you know are coming in the future so that you can avoid debt.

It is those timeless principes, when well understood, that will guide you no matter what the economy is doing. Specific advice is usually just a clarification of those principles for the current moment, and when those moments pass, that specific advice becomes far less useful. It is far better to understand the true ideas behind them.

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