Is Dave Ramsey right?

Treść źródłowa

I see way too many Dave Ramsey videos online…His advice seems entirely hokey. Use cash envelopes. Grocery budget in one envelope, entertainment in another. When the envelope is empty, stop spending. Pay off your smallest debt first, regardless of interest rate. Build momentum. Feel the wins.There’s one type of economist (me, that’s me), who winces at this. Money is fungible—a dollar in one envelope is worth the same as a dollar in another. Paying low-interest debt before high-interest debt leaves money on the table. These rules violate basic principles of optimization.There’s another type of economist (me, also me, when I’m being a better economist), who says wait. Millions of people swear by the envelopes. And it’s not just Ramsey. Rules of thumb are everywhere: round down small purchases, treat sunk costs as sunk, set aside money before you see it. Personal finance is full of these heuristics that look wrong to an optimizer but seem to be popular in practice.So let’s flip it around: what constraints make this behavior sensible? What problem does it solve? Why do people rely on heuristics when making decisions?This Substack is reader-supported. To receive new posts and support our work, consider becoming a free or paid subscriber.Cognitive Costs Are ConstraintsA core of economics is about people maximizing subject to constraints. Usually, economists focus on budget constraints. Sometimes we add time constraints. But there’s another constraint that price theorists have long taken seriously: cognitive costs.Decision-making takes effort. Comparing options requires attention. …