Beyond the Numbers

Adam M. Grossman

BACK IN THE 1950s, economists Franco Modigliani and Merton Miller developed a theory that, even today, is taught in virtually every finance class.

To understand the theory, suppose you’re running a company and want to build a new factory. To raise money for the project, you generally have two options: You can sell shares to investors or you can borrow money. No one disputes that basic framework, but Modigliani and Miller added a twist: They argued that, whether the company issues shares or it takes on debt, investors shouldn’t value the company any differently.

That’s the theory. In reality, most people raise an eyebrow when they hear this. That’s because debt always carries risks. Should something go wrong, an unhappy lender can, at the extreme, force a company into bankruptcy. These risks might not be quantifiable, but they’re real nonetheless. This sort of thing occurs frequently in economics—where the formula says one thing, but the reality is more nuanced.

It’s the same in personal finance. I often say that there are two answers to every financial question: What the numbers say and how you feel about it. That, in fact, is a big part of what makes personal finance so tricky. Few questions are purely mathematical. Many—maybe even most—lie at the intersection of factors that can be quantified and those that can’t. Here are five examples:

1. Spending. This is a tradeoff between enjoyment today—something that’s real but hard to quantify—and financial security tomorrow, which is much easier to quantify. We all intuitively understand this and try to strike the right balance. But it isn’t always easy. According to the book Happy Money, there are more than 17,000 academic articles that examine the relationship between happiness and money.

The Happy Money authors identify certain rules of thumb that can help. Among the best known: Buy experiences rather than things. Use your money to buy more time for yourself by, say, paying others to do tasks you dislike.

But at the end of the day, even these rules are subject to interpretation. If you buy a convertible or a vacation home, do those count as things or as experiences? I’d argue they count as experiences—and thus are money well spent. But others might see them as frivolous. My advice: The best thing we can do when making spending decisions is to be intentional about them.

Most of us are busy, so our financial lives run on autopilot. But with many companies quietly billing our credit cards each month, it’s more important than ever to be intentional about spending. An approach I recommend: Hold an annual financial review. Some people do this each Jan. 1 so they don’t forget. However you structure it, the key is to review your spending and to ask a basic question about each significant line item: Even if we can afford it, do we need this item? Will it make us happier—or our lives easier—or would we instead be happier having those dollars in the bank?

2. Charitable giving. Like spending, charitable contributions involve a tradeoff between giving today and perhaps saving the money for tomorrow. But it involves two additional dimensions, one quantifiable, the other not. The quantifiable dimension is, of course, the tax benefit. The unquantifiable dimension is the satisfaction that giving can provide.

How can you balance all these factors? As I described a few weeks back, the first step in making a giving plan is to understand your “why” and the goals you’re trying to accomplish. This question is itself multidimensional. But just like day-to-day spending, I think it’s important to be intentional about it.

3. Investments. How should you invest your savings? This question gets a lot of attention, but it’s mostly focused on the numbers: risk, return, liquidity, expenses and so forth. To be sure, those are important. But there are additional dimensions to the investment choices we make.

For starters, it’s important to be clear about your objective. As one client put it, know your definition of “winning.” Is there some number that you define as enough? Or are you trying to grow your investments to as large a number as possible?

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Beyond that, do you view investments simply as a vehicle to support your goals? Or do you derive enjoyment from the investment process itself—whether it’s reading through the literature, picking stocks or making angel investments? The reality is that there are many ways to manage money successfully. You shouldn’t let anyone else tell you what’s right or wrong. It’s important, though, to be clear in your own mind about your objectives.

4. Tuition. College tuition is a component of spending. But it’s significant enough to warrant its own category. Suppose your child gets into Harvard, Yale or another school with a similarly sky-high price tag. If you don’t qualify for financial aid, it’s going to cost a bundle. On the surface, you might immediately rule out such a luxury. But it’s tricky.

In one respect, tuition is a spending decision. But it’s also an investment decision—because a college education should deliver a positive return on investment. The challenge for many families: This investment in their children comes at the expense of their own financial security. Compounding this challenge: Ideally, college also delivers unquantifiable benefits outside the classroom. It’s nearly impossible to know how to factor these benefits, which are potentially significant but totally intangible, into a financial decision.

How should you approach this decision? Step one is to recognize that U.S. News & World Report is not the only judge of school quality. There are other measures, including Money’s rankings, which evaluate schools along many more dimensions than U.S. News. As a result, the Money rankings highlight a much more diverse list of schools.

5. Housing. In many ways, housing decisions are like tuition decisions. Both carry enormous price tags. And like college, housing is partly an expense and partly an investment, and it has other dimensions as well. For instance, for many folks, it crosses over into the “experience” category.

Housing, however, does differ from tuition in one crucial respect: If a house ends up being too much of a burden, you can almost always sell it. By contrast, there’s no way to get a refund for a poor college education. For that reason, I’d worry less about housing decisions than about college choices.

These are just a few examples. Other topics that lie at the intersection of quantifiable and unquantifiable include Social Security, life insurance and estate planning. There’s no magic bullet for addressing any of these topics. Still, a useful starting point in decision-making is to simply recognize that these intersections exist.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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David Powell
David Powell
1 year ago

I love your approach to some of these choices involving math and emotion, which we all struggle with: find a range of acceptable options and split the difference between the extremes. A “middle way” unfreezes action to diminish opportunity cost, and stops perfectionist tendencies from over-working a problem with diminishing returns.

Rick Connor
Rick Connor
1 year ago

Great article, Adam. I see this this behavior all the time. I had a conversation with a colleague two days ago. He is one of the smartest rocket scientists I know. He has a choice in taking his pension as an annuity or a lump sum. The pension plan has an early retirement subsidy feature that makes the annuity about 35% more in PV than the lump sum. But the lump (especially in todays low interest rate environment) is a big number. He understands the math, but the thought of turning down that big sum is tearing him apart.

1 year ago
Reply to  Rick Connor

There are a number of smart math columnists and readers here on HD. Have any of them/you created a spreadsheet to input various numbers and assumptions to then pop out whether taking the pension as a lump sum or an annuity based on that specific set of data inputs is the better option? Are you willing to share it? Thanks.

1 year ago
Reply to  Guest

Hi, Guest.

You’ve posted questions in response to A. Grossman’s posting Beyond the Numbersan article that invites readers to think about the quantified and non-quantified factors that go into making financial decision like the one on your mind… choosing between taking pension as annuity or as a lump sum.

Even though I’m a spreadsheet nerd, no, I didn’t develop a spreadsheet before making my choice to take pension as annuity. Didn’t need to. Instead, it was some NON-quantitative factors that caused this to be the right decision for me:

  • a family history of longevity
  • excellent health
  • laziness – not wanting to add to my workload of investment-management

Choosing the lump sum will be the right decision for many other people. But you won’t find the NON-quantitative factors for this decision in any spreadsheet. Instead, they’re found in your answers to three questions:

  • Do I have the self-discipline to resist spending the lump sum so that it can grow (or generate income)?
  • Do I have education, experience, and self-discipline needed to put that lump-sum to work and continue maintaining it?
  • What benchmark will I use as a signal that it’s safe to begin decumulating?

As Mr. Grossman’s article says:

There’s no magic bullet for addressing any of these topics. Still, a useful starting point in decision-making is to simply recognize that these intersections exist.

Last edited 1 year ago by OUTinMinnesota
Rick Connor
Rick Connor
1 year ago
Reply to  Guest
Jonathan Clements
Jonathan Clements
1 year ago
Reply to  Guest

One way to see whether the pension or lump sum is the better bet is to look at pricing on deferred income annuities:

Even if the pension proves more compelling — at least relative to the pricing of deferred income annuities — you’d still want reasonable confidence that you (or you or your spouse) will live into your 80s.

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