John Y. Campbell is the Morton L. and Carole S. Olshan Professor of Economics at Harvard University, where he has taught since 1994.
Campbell has published over 100 articles on various aspects of finance and macroeconomics, including fixed-income securities, equity valuation, portfolio choice, and household finance. His books include Fixed: Why Personal Finance is Broken and How to Make It Work for Everyone (with Tarun Ramadorai, forthcoming Princeton University Press 2025), Financial Decisions and Markets: A Course in Asset Pricing (PUP 2018), The Squam Lake Report: Fixing
the Financial System (with the Squam Lake Group of financial economists, PUP 2010), Strategic Asset Allocation: Portfolio Choice for Long-Term Investors (with Luis Viceira, Oxford University Press 2002), and The Econometrics of Financial Markets (with Andrew Lo and Craig MacKinlay, PUP 1997).
What if capitalism itself is confusing your personal finance decisions? In this week’s episode, Harvard economist John Y. Campbell joins us to unpack his new book, Fixed: Why Personal Finance Is Broken and How to Make It Work for Everyone, co-authored with Tarun Ramadorai. John argues that the financial system—while essential—is failing ordinary people through complexity, hidden costs, and misplaced incentives. Drawing on decades of research in household finance, he explains why products are too expensive, advice too conflicted, and decisions too difficult, and how policy and design can fix it.
Key Points From This Episode:
(0:04) Introduction – Rational Reminder’s focus on sensible investing and decision-making.
(1:46) Why Canadian finance feels broken: complexity, branding, and lack of competition.
(4:53) Introducing John Y. Campbell and his new book Fixed.
(5:43) The role of the financial system in everyday life: smoothing income, enabling investment, and managing risk.
(7:14) The two main problems in modern finance—products are too complicated and too expensive.
(9:17) Why financial decisions are so hard: our brains didn’t evolve for math, and temptation bias wins.
(11:36) How far financial literacy education really helps—and its limits for inequality.
(14:26) The “corruption of capitalism”: how capitalists exploit consumer confusion and misperceived value.
(18:15) Cross-subsidies: how the mistakes of the poor often subsidize the wealthy.
(21:05) Competition only works when consumers can compare price and quality.
(22:15) Financial innovation—when technology helps vs. when it deceives.
(24:24) Conflicts of interest in advice: why “trusted” advisors often don’t act in clients’ best interests.
(26:26) Why loyal, long-term bank customers often get worse deals.
(27:20) The illusion of opting out: why avoiding finance (or choosing crypto) is “jumping out of the frying pan into the fire.”
(30:24) The global emergency-savings problem—why volatility hits the poor hardest.
(32:26) Is college worth it? Returns, costs, and who actually benefits.
(35:47) How to think rationally about buying versus renting a home.
(38:16) Housing in retirement—why reverse mortgages make sense but are misunderstood.
(40:25) Mortgage mistakes: not shopping, not refinancing, and the racial gap that results.
(44:41) Using utility theory to make better insurance and investment choices.
(46:55) Principles for investing in stocks: participate, diversify, minimize fees, and ignore short-term noise.
(48:24) How real investor behavior deviates from these principles—chasing returns and confusing investing with gambling.
(51:17) Insurance mistakes: overinsuring small risks, underinsuring big ones.
(54:11) How much to save for retirement—and how most people fall short.
(55:40) Lifecycle investing: why target-date funds are good but could be better.
(57:56) Why annuities make sense, and how better framing could make them more popular. (59:30) Technology’s double edge: lower costs but higher temptation and discrimination.
(1:02:17) Lessons from crypto: why stablecoins matter and what regulators should learn.
(1:05:26) From nudge to shove: how governments should actively design simpler, safer products.
(1:10:02) Where regulation goes too far—and why governments shouldn’t run finance directly.
(1:13:10) Priority areas for reform: retirement accounts, transaction accounts, and insurance.
(1:14:49) The four design principles for a better system: simple, cheap, safe, easy.
Read The Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We are hosted by me, Benjamin Felix, Chief Investment Officer, and Cameron Passmore, Chief Executive Officer at PWL Capital.
Cameron Passmore: Welcome to episode 380. This week's conversation was a timely one. I've been thinking about this a lot as we had this conversation about how to kind of frame it.
I think back to Ben, you and I did a couple of meetups out in BC, and the reaction was very much appreciated, but it was a little surprisingly over the top. But I think that's a reflection, and you and I talked about it afterwards, it's a reflection that kind of what we stand for in Canada really sticks out like a sore thumb. And today's conversation with Professor John Y.
Campbell and his new book really tied it all together for me. It's just so fascinating how the timing of all this came together and what we're living, especially in Canada, and he talks about the Canadian experience. And it comes down to the line I wrote down is capitalism is broken in finance in Canada, where you've got a financial system that is so complicated for the average person that has come down to brands, and it doesn't come down to the decision of where to go, doesn't come down to quality or price, it's about brands.
And you and I have talked about that a lot. I just think that John is such a great researcher and communicator, and he's so passionate about this, about making a difference. And it's nice because he doesn't simply throw arrows at the issue, he actually comes up with some policy suggestions for change or making it better. This conversation was incredible.
Ben Felix: I just want to say real quick, when you said the reaction of people at the meetups was over the top, you mean that it was like people were so unbelievably appreciative to the point where you and I couldn't believe that they were so appreciative. And that was because we had taken this complex, confusing financial world and given people relatively straightforward, actionable stuff that allowed them to feel much more confident. And people are just so appreciative of that, that's what you're talking about.
And that's basically what John's book is aiming to do. He lays out a lot of the important financial decisions that people make throughout their lives, the mistakes that people make, the normative advice, like what an economist, what he as an economist and his co-author would tell people they should do, and how all of that interacts with the current financial system, which in a lot of ways, not just in Canada, but all around the world is not great. The interaction between individuals and financial companies, corporations, capitalists, as John calls them in the book, is often detrimental to individuals.
And that happens for a whole bunch of different reasons that we talked about in the episode. There's also a quote from the book that to me just captures the whole essence of the book. I read it during the conversation with John.
He says something, he says basically that section of the book that refers to that quote, but I was like, I got to read the quote because it's so good anyway. So I'm not going to read it again now, but you'll hear it during the episode. It's fascinating the way that they've been able to, the framework they've been able to put that interaction between the consumer and capitalism.
And then like you said, Cameron, not only why is this detrimental in a lot of cases, but how can we fix it? That's the premise of the book is new book is called Fixed: Why Personal Finance Is Broken and How to Make It Work for Everyone, co-authored with Tarun Ramadorai.
It comes out two days, we understood from talking to John, two days before this episode is released. So when you're hearing this, that book will be available for sale from Princeton University Press. I read it to prepare for this conversation.
We got a pre-read copy and I thoroughly, thoroughly enjoyed it because it takes so much of the literature in household finance, which is the study of how do people actually make decisions and how does that differ from what normative advice says. It takes so much of that literature and makes it digestible for somebody who doesn't necessarily, who doesn't need to read the paper, which I think is pretty cool. It takes all that research and makes it accessible, which is obviously really important.
Okay. So real quick, John Y. Campbell is the Morton L. and Carol S. Olshan Professor of Economics at Harvard University. He's been there since 1994.
It doesn't really need an introduction, honestly, but he's published over a hundred articles on various aspects of finance and macroeconomics. He's written several books, including some very popular textbooks, which we read to prepare for our conversation with him last time, which was lots of fun. But yeah, like I said, I mean, he's one of the most well-known financial economists in the world today.
So I don't know how much more introduction he needs.
Cameron Passmore: If you want to listen to the other episode, it's episode 250. That was the last time that John joined us.
Ben Felix: So this is a wide ranging episode. We talk about really the book and therefore this conversation, really try to cover a broad cross section of household finance, of personal finance to use the more colloquial as opposed to academic term. So it's like the broad overview, what decisions are people making?
What mistakes are people making? How is the financial system interacting with that? And what can we do to make it better?
Cameron Passmore: Good to go.
Ben Felix: All right. Let's go to our episode with John Y. Campbell. John Campbell, welcome back to the Rational Reminder Podcast.
John Campbell: Thank you. It's a pleasure to be with you.
Ben Felix: It's a pleasure to be talking to you again. And I thoroughly enjoyed your new book, which is primarily what we're going to be talking about today. You guys did a really nice job.
John Campbell: Thank you.
Cameron Passmore: So to start us off, can you explain to us what is the role of the financial system from the perspective of an ordinary person?
John Campbell: Ordinary people use finance in many different ways. First one is just to smooth out the ups and downs in income. People have a lot of volatility in their lives and many people have quite unstable income and also emergency spending needs that pop up.
And you need to have resources to handle that. You hopefully have some savings. If not, you may need to borrow.
A second purpose is to move resources from the middle of your life, where most of us in middle age have more income relative to our spending needs. And we need to move that income to where we need it in life. We need to move it early in life to help fund some of the large investments we have to make early on, pay for higher education, buy a house.
And then we need to move those resources late in life in order to live comfortably after we retire. The financial system also enables us to make small investments in risky, productive projects. Very few of us can buy a container ship or a factory, but we can buy small shares of things.
And then the financial system helps us manage risks. We have to insure against natural disasters, against health problems, against early death that might take us away from our families and leave them in need. So these are all vitally important functions of the financial system that we all use in our lives.
Cameron Passmore: How do you describe the main problems with the financial system in its current state?
John Campbell: Well, basically, I would say that financial products are too complicated and too expensive. So complicated, they're just hard to manage, confusing to shop for. People get very reluctant to shop for financial products because they feel, I don't really understand them.
They're hard to compare. And you know, after you buy them, they're very often hard to manage. You have to make decisions.
You have to know to avoid hidden fees, things like overdraft charges, late fees on credit cards. You need to know when to take certain actions like refinancing a mortgage at a good time. This is just hard stuff.
And then because these financial products are complicated and we don't like to shop for them, that enables financial product providers and service providers to really compete more on branding and less on price and quality. It's all too common to just go to your bank that you know and regularly use and take whatever product they offer you. I know, for example, in Canada, that that's very common when choosing a mortgage.
But really, if people shopped around more, they'd be able to get better prices. We think too complicated and too expensive are the big problems. Finally, I would say expensive, particularly for people who have less education and less financial sophistication, less experience.
I mean, if you're a savvy person working in the financial industry or, you know, you're a finance professor, maybe you do pretty well. But there are a lot of other people who don't. And one of the things we highlight in the book and we're very concerned about is the unequal impact of these problems on our population.
Ben Felix: There's a ton of depth to all of the stuff that you just said. You say it so fluidly, but I'm thinking about all of the research that backs it up, like the difficulty in comparing the cost of financial products even is such an interesting topic. Can you talk about what makes financial decisions so difficult for people to process?
John Campbell: Well, the truth is that the human mind didn't really evolve to solve financial problems. We have to learn that. It's inherently mathematical.
You have to be willing to do some calculations and think numerically. And that is not intuitive for many people, and it needs a lot of education, which is sadly in many ways lacking. When we make intuitive decisions, we often use certain rules of thumb that can lead us astray.
So one example would be thinking in the wrong units. So just for example, suppose you want to be a good shopper, so you have a keen eye for discounts. It's natural to think about the percentage discount, but a 20% off on a bottle of shampoo is very different than 20% off on the car or an insurance policy.
Often people devote too much effort to chasing small discounts on small-ticket items and don't think enough about the large-ticket items where a smaller percentage discount would really be worth more in dollar terms. So the question of what units to think in is something that really confuses people. I would also like to say that beyond the cognitive issues, there's just the difficulty of struggling with temptation.
This is something that human beings have dealt with for the whole existence of our species. There are old-fashioned ways of talking about temptation and so forth. The modern economics language about this is called present bias, which means valuing the good stuff in the present and really valuing it too much relative to the future, and conversely, putting off anything that's painful and unpleasant.
So why don't people save? Why don't they accumulate an emergency fund? Well, that flies in the face of the temptation to meet the needs of the present moment.
Why don't people shop around for financial products and get the best price? Well, it's unpleasant, and maybe you think you're going to get to it next week, and then you never do. So that's another aspect of the problem.
Cameron Passmore: You mentioned education, John. How effective is financial literacy education at improving financial behaviors?
John Campbell: So I'd like to say that I'm very committed to financial education. I think it's very important, and I'm in the business because in college at Harvard, I teach a personal finance course that has no prerequisites, and this year I have almost 350 students taking the course. I'm very glad about that, and I think what I can teach them is both useful and intellectually valuable as an introduction to economics.
Having said that, we must always remember that college financial literacy education is just going to help people who, in any case, are going to end up towards the top of the income distribution, the top, let's say, one-third of the population. So we can't really solve the inequality problem with college financial education, no matter how effective it is. Of course, there's a movement to offer financial education in secondary school, in high school in particular.
I'm also very committed to that. I'm on the board of a non-profit called the Council for Economic Education, which does great work promoting both economics and personal finance education in high schools. Many US states now require this as part of the curriculum, and I think that's a good thing to do.
But I think we should have realistic expectations about what can be achieved with this. There's a number of problems. One is that to teach personal finance well, you need to have good math intuition, and that's the scarcest resource among high school teachers.
Those people are math teachers very often, and they're very few and far between and very valuable. A second issue is that high school students are not yet making many of the big decisions that they have to make. Yes, maybe they might have a first credit card, maybe they might be taking out some student debt.
So the first few decisions are coming along, but many things are further away in life. I like to make the analogy with driver's ed. Can you imagine how effective would driver's ed be if the students never got behind the wheel, but just sat in the classroom and heard about the rules of the road?
Well, I don't think they would remember very much. And that's the same problem that we have with finance education. Finally, of course, there's all this financial innovation.
The products are always changing, the terminology changes, there are new tricks and traps. So you have to continually refresh the education to keep up with this. So I think it's very worth trying, very worth doing, but it's not a complete solution in itself.
Ben Felix: And learning's hard. For a person to want to learn, part of it's being able to do it, like the driving example, but it's just learning's hard, period.
John Campbell: Look, we think there's a role to try to make things easier, diminish the gap between where people are at and what they need to know.
Ben Felix: This question is probably my favorite question related to the book. And I sent you a quote from the book when I sent you these questions ahead of time, because I think it's just the most overall powerful concept. Can you explain how capitalists, business people, financial companies, respond to investors or individuals who misperceive the benefits and costs of financial products?
John Campbell: Yes, this is indeed the heart of the book. And we have a chapter called The Corruption of Capitalism, where we talk about this. What's the idea of capitalism?
It's that competitive, profit-seeking business people will compete to meet the needs of customers at the lowest possible price and the best possible quality. And I would argue that there's a lot of evidence that that basic insight is correct, and that capitalism can be very effective. However, it depends critically on people knowing what they want and need, and being willing to shop on the basis of quality and price.
And the difficulty in this context is that investors are confused. They don't really understand the benefits of financial products. They're easily distracted by shiny features like, let's say, a floor on an investment return.
Oh, you can never lose money, something like that. That'll attract a lot of attention, and they'll miss other disadvantages of the same product. People also fail to see all the costs associated with a product.
You might focus on an initial APR on a credit card and not realize that rate's going to reset after a year, or that it'll reset if you make one late payment, these kinds of things. So there are hidden costs, hidden benefits. Well, what happens?
Capitalists respond to the needs that people think they have, the demands that they are expressing in the marketplace, not the demands that they should have if they were really acting in their own self-interest. So, of course, the same competitive capitalist system delivers the wrong products with overappreciated benefits and hidden costs. And we have many, many examples of that in the book.
There's more to it than that, because since people kind of know how difficult this is, they are reluctant to shop, as I mentioned. And that means that financial firms often have market power in the retail space. They can mark up their products, and they can compete on the basis of brand.
One example is that I live in a suburb of Boston, Lexington, that has a high street, a main street, with many, many bank branches. And they're all empty, basically, except for an ATM and somebody sitting there twiddling their thumbs. And why does this happen?
Well, the banks are competing to make people believe that there's a physical branch, it's a safe place to put my money. It's branding. And, of course, this is a wasteful form of competition that really, really doesn't add value.
A lot of the profits that could be made are actually dissipated in this type of branding competition for naive customers who don't know that they should shop on the basis of price and quality. And then finally, there are all the mistakes that people make when they manage their products. So a big example that I like to talk about is mortgage refinancing, particularly in the U.S. with our long-term fixed-rate mortgages. But also in other systems, mortgages reward keeping an eye on interest rates and refinancing in an advantageous moment. And you have the right to do that, and you can lower your rate by doing that. In the U.K., where they have adjustable-rate mortgages, this plays out with teaser rates. You get a low rate early on, and then it resets to a high rate, and you want to jump from one teaser rate to the next. Well, many people don't do that, and particularly less educated and poorer people don't do that. They then provide extra revenue to the mortgage lenders, which in turn, the mortgage lenders are competing for business, and part of what they do is they lower mortgage rates up front for everyone.
Well, that's great if you know how to refinance. I have a lower mortgage rate than I would have in a world where everybody refinanced promptly. But my cheap mortgage is in part being subsidized by the mistakes of others.
It's a reverse Robin Hood transfer from the poor to the rich. And once you see that, you see it everywhere. It's there in credit card rewards.
It's there in cheap checking accounts. It's there in life insurance premia. It's a big problem, and we call it cross-subsidy.
There's academic work on this, which uses the term shrouded equilibrium done by my colleagues Xavier Gabaix and David Laibson. This is a very troubling perversion or corruption of capitalism.
Ben Felix: Shrouding is crazy. I think we see that so much in financial products. You mentioned the floor on an investment referencing a structured product, and it's like, those are so complex.
It takes a PhD literally to figure out what should this thing cost, and a random person walking into a bank being like, look what you could earn on this thing, and you won't lose money. There's no way they're going to be able to evaluate that.
John Campbell: Structured products we know are a little bit complicated, but just even plain vanilla mortgages that everybody has, the optimal refinancing problem, that's a real options problem. That's not even in textbooks. And of course, people refinance with a certain amount of randomness.
Sometimes they do more of it, sometimes less in a way that's very unpredictable. That generates the phenomenon of prepayment risk in mortgages, which in turn, the industry hires very sophisticated researchers, PhDs, to model prepayment risk. The irony is that we have this hard to hedge, hard to model, hard to understand form of risk in financial markets, which arises from the fact that we've given ordinary people a product that they don't know how to manage.
Ben Felix: I want to read the quote real quick that I sent you by email. You said most of this, the way that it's written is just so elegant. Capitalists respond to the actual demand for their products, not the demands that would exist if people were perfectly rational and truly understood their own best interests.
Since people's demands are driven by the benefits they perceive rather than the benefits they actually get, the financial system supplies too many products with exaggerated benefits and too few products with underappreciated benefits. Since perceived costs rather than actual costs drive people's demands, the financial system supplies too many products with hidden costs. It's just like, man, it's just so good.
John Campbell: Thank you. Thanks.
Cameron Passmore: What effect does competition have on the pricing of financial products?
John Campbell: We think that critically depends on how ordinary people are shopping. If we can simplify the product so that they shop on the basis of price and quality, then competition is going to deliver low price and high quality. If on the other hand, people are shopping on the basis of familiarity, big brand names, and so on, then what competition will deliver is a lot of advertising and other forms of expense like opening up empty bank branches that will help the financial firms hang on to their customers, but won't actually improve price or quality.
We think competition can be good, but there are some preconditions for it to deliver on its promise.
Ben Felix: There's been this big push in Canada recently for exchange-traded funds that use covered calls, writing call options on equities that the fund owns, and then levering that back up to a higher expected return, which to me, I think these products are kind of crazy. I've made a couple of videos about them recently, but they are kind of innovative, like putting that in an ETF wrapper. It's like, hey, that's pretty cool, even if I don't think it's a good idea.
Can you talk about, generally speaking, who innovation in retail financial products benefits?
John Campbell: I would say it's a mixed picture. Some innovation that's driven by technology really has lowered costs for small savers and small investors. Fundamentally, IT lowers fixed costs.
You don't need to hire somebody writing in a big paper book to keep track of accounts. You have software to do that. All kinds of things can be done on a small scale, whether that's just plain vanilla banking, or whether it can be credit extension, it can be equity trading.
Lots of things are very cheap. Stock trading is much cheaper than it used to be for small investors. It's also possible to customize.
Think about robo advising, which offers customized financial advice at low cost. There are definitely innovations that are very beneficial. There was this famous remark that Paul Volcker, the former chairman of the Fed, made at one point where he said, the only kind of financial innovation that I think was worthwhile was the ATM.
I disagree with that. I think there's a lot else that's gone on. But having said that, there's also innovation that is designed to come up with a new complication and confuse people and create demand through confusion.
Structured products, since you brought them up, why do they appeal? Why would an ordinary person want to have a put option, a nonlinear payoff structure, to use the technical term? Well, one reason I think is that people are not thinking about interest and the interest they're giving up.
If they're told you cannot lose money, that in other words, your return can never be negative in nominal terms, they forget about the fact that they should be earning interest. If they had a safe investment, they would earn interest. So it sounds like a cannot lose deal, but of course you can lose and you are in fact losing the interest rate.
That loss of the interest rate then is what gives the structured product issuer the resources to both put in some shiny features that attract the customers, but also then take a very handsome profit for themselves.
Cameron Passmore: So, John, what makes conflicts of interest in retail finance such a big problem for consumers?
John Campbell: The problem really is that consumers are often very naive about the financial interests of the people they're dealing with in the financial system. The financial system is bound to have counterparties and in any commercial transaction, the seller and the buyer have different interests. But unfortunately, while people understand that when the job title of the person they're talking to is salesman, and they probably know to be wary of car salesman, they're often very naive about the people who work in banks, brokerage firms, neutral fund companies, and so on.
And they ignore the fact that those people have their own interests. There's survey evidence that people really just don't quite get that very often the person on the other side has their own motivation to sell a product that maybe has a high commission or at any rate generates high fees for the company they work for. So they're not wary enough.
The problem, of course, is even more severe if we're talking about financial advice. It's important for people to find financial advisors that they can trust who are going to act in their interest, the customer's interest, not the advisor's own interest. There is, of course, a good amount of regulation enforcing fiduciary duty, the legal duty to act in the customer's interest on the financial advice industry.
But unfortunately, when you look at the records of enforcement, there's also a lot of evidence that financial advisors don't always live up to that, particularly when they have older and less sophisticated customers who may be naive, who may be easy to exploit. So this is another serious type of problem that we face in finance.
Ben Felix: And there was just a report done by the regulator, two of the securities regulators in Canada, where they looked at the conflict of interest in sales practices at Canada's big bank mutual fund dealerships. And I mean, kind of like what you just said, it painted a pretty bleak picture of what people are actually getting when they go in looking for advice.
John Campbell: Let me just make one more point. Many people feel instinctively that if they've been a long-time customer of a bank or a big financial institution, then they must be a very valued customer who will be well-treated. And actually, it's the opposite.
Somebody who's been a customer for a long time, the bank will tend to assume that they're not shopping around, they're not very alert, and very often they could be offered a higher price than somebody might be offered who walks in off the street or who is visibly shopping around.
Ben Felix: That's so interesting you say that. I spoke at an event for Seniors Day in Canada last week. That was the sentiment in the audience, where they were like, one of the topics we talked about was these conflicts of interest at the bank.
And several people said, exactly what you just said, I feel like I should be getting treated really well because I've been a customer here for 50 years. But as you say, it's often the exact opposite.
Cameron Passmore: Wild.
Ben Felix: It is wild. So kind of related to that, what are the downsides of just avoiding the financial system? Someone hears everything we've said so far, and they're like, I don't want anything to do with that.
I'm just going to store cash under my mattress or buy gold or buy Bitcoin or something like that.
John Campbell: Yeah, unfortunately, that's a very common reaction. And we talk about it in the book, and we say basically people are jumping out of the frying pan into the fire. So you can keep cash under your mattress, you won't earn any interest.
And that's a big problem, particularly in an inflationary environment. Many people also turn to informal sources of credit, borrowing and lending from friends and family. But that can also be problematic because on the one hand, it can be hard to get your money back.
On the other hand, the social sanctions for default, if indeed somebody does enter financial distress, can be extremely painful and unpleasant. So other people turn to informal moneylenders, loan sharks, and so on. That's not so much a problem in Canada or the U.S., but in many parts of the world, there are criminals who will lend you money, but they have their own ways of getting repaid, and it's a very dangerous path. And then finally, crypto. Crypto appeals particularly to people who distrust the financial system. In the U.S., actually African Americans are disproportionately interested in crypto because of their painful history of being mistreated by big white-owned businesses. And so crypto seems like an alternative. But first of all, crypto investments are very speculative. Yes, crypto prices have gone up a lot recently, but it's a wild ride.
A lot of the parallel financial institutions that exist in the crypto space, crypto exchanges and so forth, are completely unregulated, very vulnerable to frauds and scams, runs, panics, collapse. There are endless horror stories. So we think people who opt out of formal finance are jumping out of the frying pan into the fire.
And furthermore, society needs the formal financial system because this is what funds productive investments, and the modern economy depends on having a well-functioning financial system. So if people opt out, or if just politically finance becomes very unpopular, then it's easy for populist politicians to rail against finance, and perhaps it'll lead to policies that will be economically destructive. So we're interested in reforming finance in order to save it, rather than replacing the system in any sense.
Ben Felix: Yeah, that seems a lot more sensible than when crypto, especially when it was really gaining steam. A lot of the narrative was like, we're going to burn down the existing financial system, or it's going to collapse anyway, and we're going to replace it with crypto. But I think fixing what we have probably makes a lot more sense.
You mentioned consumption smoothing, although you explained it in a less academic way earlier, when we were talking about just how people interact with the financial system. Can you talk about how important it is for people to have access to emergency savings or credit just to fund lumpy consumption?
John Campbell: It's extremely important. Why? Because many, many people have very volatile income.
There are people who own small businesses, it's a wild ride. There are people who work for seasonal businesses, or small businesses, or who have part-time employment. When you study the income profile of working-class people, certainly in America, but similar patterns elsewhere, when you look at the month-to-month volatility, it's very extreme.
You wouldn't necessarily see it if you just looked at their tax returns every year, but it's month by month. Then there are similar spikes in spending. Your car breaks down, or your pipes burst, or maybe your daughter gets married.
Important spending needs come up, and you need to be able to fund those. Yet, at the same time, very few people, relatively few people, can actually finance three months of the normal consumption spending, which is a standard benchmark of having an adequate emergency fund. I would say you should have more than three months, but let's take three months as the benchmark.
In the US, 40% of people are financially vulnerable, meaning they can't do that. They don't have the three months. In the UK, it's about 50%.
In a country like South Africa, it's 90%. I'm mentioning these other countries, let me say, because our book has a global perspective. We're not just writing about the US or a few developed countries like the US, Canada, the UK.
We're really trying to talk about the whole world. Of course, if you don't have the emergency savings, and you do need money, then you're going to have to borrow of short notice, and that tends to be very expensive. Whether it's borrowing on a credit card, maybe not even making your minimum payment, so you have to get a late fee, or whether it's taking out a payday loan, which often has an APR of something like 500%.
Short-term unsecured credit arranged at short notice is really, really expensive.
Cameron Passmore: How should someone decide whether to go to college?
John Campbell: That's a great question, and one that we talk about in the book. We talk about funding big investments, by which we mean basically college and houses, although you could also talk about cars. College, we argue, is an investment that actually has a very high return for most of the people who go to college.
That doesn't mean it would have a high return for everybody else. You have to have the cognitive skills and the desire to study something in college. It's not going to be for everybody.
But for the people who go, and we argue for quite a few other people as well, actually, the real rate of return is very high. You measure that by looking at the income gain for college graduates over high school graduates, and then you adjust for the cost of college, because it's an investment that you have to fund. But if you calculate college as an IRR and look out, say, 20 years, you get real rates of return that are often between 5% and 10%, which is considerably more than the real interest rate that people will have to borrow at.
It's particularly helpful to keep down the costs. If you're in the US going to a public university in the state where you live is often the most economical thing. For many people, it may also make sense to start with a two-year college, a community college, go to that at a reduced rate, and then transfer to a four-year college.
So there are ways to keep down the cost. But we argue college is a good financial investment. You do also need to think about what it is you're studying and what the rate of return is by the field of study.
Generally, STEM fields have had higher returns, as well as fields that have stable and growing employment, like nursing is an example.
Ben Felix: I have a couple of follow-up questions. On the rate of return from going to college, can some of that be explained by selection bias, like people who would have made more money anyway end up going to college?
John Campbell: Certainly selection is important, and particularly at elite colleges. I would not claim that the high incomes of my former students have much to do with my teaching. I think I teach them well, but these are people who would succeed almost regardless.
However, when you look at the university system as a whole, the best research suggests that selection is not the main force, that actually there is genuine value added.
Ben Felix: My other follow-up question is, on the programs that tend to have higher rates of return, like STEM and nursing you mentioned, how persistent should people expect things like that to be over time? I think a lot of people over the last 10 or 15 years looked at software engineering and said, yep, I'm going to make a lot of money. Right now, it's maybe not as obvious that that's true.
John Campbell: That's certainly true. That's a good argument for the traditional vision of college education as training your mind to keep up with a very rapidly changing world and figure out whatever you need to figure out to move forward. I think it argues for not being too narrowly vocational in your vision of higher education.
I would also say that I think the people who are going to thrive the most, even in the world of AI and other advances, I think are going to be people who can combine analytical skills with softer human skills, communication, understanding other people, being able to work in teams and so forth. I think that's the sweet spot is to have that combination of skills.
Cameron Passmore: How should people decide whether to buy a home?
John Campbell: Many people, I would say, approach this the wrong way. In countries and regions where house prices have been going up, a common thing that people say is, house prices always go up, you've got to get on the housing ladder, buy the biggest house you can afford as soon as you can scrape together and borrow the money. It's your ticket to the middle class.
I think that is wrong. The problem is that house prices are very hard to predict. Just because they have been going up doesn't mean they will continue to go up.
You shouldn't chase performance in housing just as you shouldn't chase performance in the stock market or other risky asset markets. What I think is important to consider is, first of all, the preferences you have about the type of housing you want. Younger adults who love living in cities in dense urban areas may very well want to rent an apartment.
On the other hand, if you've started a family and you want good schools for your kids, you want to live in a suburb, very often most of the housing is owner-occupied housing and you will want to buy a house for that reason. That's not a financial reason exactly. It's a lifestyle point.
But then beyond that, you don't want to buy a house if you're very likely to move because buying and selling houses is extremely expensive. Realtor commissions and other costs and fees can easily amount to several percentage points of the full value of the house. That's a lot of money.
Unless you think you can stay put for at least three years, and I would say better five years or more, you shouldn't buy. You should try to rent. Then finally, of course, you need to be sure you have a stable enough income to support the house, to support the mortgage that you're likely going to have to take out.
Because if you get into a period of low income and you can't make your mortgage payments, you'll be foreclosed upon and you'll lose the house. That does terrible damage, both because it destroys value in the house. It's going to take away your down payment in all probability.
It's also going to damage your credit score and leave you in a very bad position. Those kinds of considerations, I think, are the ones that most people should use, not trying to predict what house prices will do.
Ben Felix: Completely agree. We talk about this a lot on our podcast. That's why Cameron's laughing.
We say pretty much what you just said in many different ways. Can you talk about, though, how the rent versus own decision for housing changes in retirement or does it change?
John Campbell: Well, in retirement, what people are often doing is trying to free up resources to live on. Hopefully, you've got your retirement savings and you draw upon that. Many people also have some component of defined benefit pension income, social security in the US, and so on.
Many people in retirement end up house rich and cash poor. If they bought a house earlier in their life, they paid off the mortgage. They've got all this housing equity and they may be short of other resources.
Then what you want to do is you want to liberate that housing equity so you can spend it and live on it. Now, an obvious way to do that is to downsize and sell your big old family house and move to an apartment or a condo in Florida or a senior community, perhaps. But there are people who don't want to do that, and I can understand that, in which case using mortgage finance actually is another way to go.
You can borrow against the value of your house and you're going to want to use an interest-only mortgage or maybe even a reverse mortgage in which you make no payments while you're living in retirement but pay later when you either pass away or move. The house is sold and then you pay off the mortgage at that time. We argue that that's a very sensible structure.
It's one that is not used enough, we think, in part because reverse mortgages are expensive to market. Seniors are distrustful and easily confused and they tend to overvalue their homes. Many older people don't realize how much value has been destroyed by poor maintenance in their long-time homes.
For all those reasons, reverse mortgages are hard to market. Then there's the problem of market power and markups. They have a bit of a bad reputation as an expensive product, but we actually think it would be good if they could be more widely used and reasonably priced.
Cameron Passmore: What are the most common mortgage-related mistakes that you see households making?
John Campbell: The most basic one is failure to shop, just taking the first mortgage quote you get.
Cameron Passmore: Incredible.
John Campbell: This, like so many behaviors, varies with what segment of the mortgage market you're looking at.
If you're looking at, in this country, jumbo mortgages, which are the big ones on expensive houses that higher-income people might be taking out, the loss from not shopping around has been estimated at something like four basis points, so not too much. But if you look at FHA mortgages, which are disproportionately used by poorer people in the US who qualify for these government subsidized mortgages, there the failure to shop is costing more like 28 basis points, so several times as much. You might say, oh, 28 basis points, how big a deal is that?
But you've got to remember that mortgage is a huge liability and a long-term liability. For a $200,000 mortgage, let's say, that turns out to be $600 or more a year for a long time. People leave money on the table by not shopping.
Then there's the failure to refinance. The type of refinancing you're going to want to do depends on the system you're in. But in the US, when fixed mortgage rates fall, you do have an incentive to refinance.
People often don't do it. There's troubling evidence of racial discrepancies in this refinancing failure. If you compare the mortgage rates that black and white borrowers pay at origination, and you control for legitimate factors like credit score, there's almost no difference.
So racial discrimination in mortgage lending at the origination stage has been well-regulated and controlled. But if you look at the rates people are actually paying on their outstanding mortgage, and you look at a time when rates have fallen, you see a black-white gap that can be as much as 50 basis points, half a percentage point. And why is that?
It's because the black borrowers have not refinanced, and they still have older high-rate mortgages, whereas the white borrowers have refinanced. And so that's a troubling problem. It's made worse in the US system by this weird institution called points, mortgage points.
So what are points? Well, you might need to borrow a little extra money to cover your closing costs. Now, normally you think, well, you'll add to your debt.
The interest rate is the interest rate, you add to the debt. But points, you don't change the face value of the debt, you change the interest rate. You borrow a little more money in effect, but it doesn't add to the official debt.
It simply changes the interest rate and raises that rate. Well, if you've borrowed using points, if you've closing costs, you have an even stronger incentive to refinance because your rate is high, you should, why pay it? You should refinance.
People don't do it. And again, particularly the less educated and poorer and racial minority borrowers don't refinance. So I would say points are a particularly confusing feature of the US mortgage system and low-hanging fruit for simple regulation to improve the system is simply ban points.
If people need to borrow their closing costs, add it to the debt. You can relax the LTV constraint to allow for borrowing closing costs, but do not change the rate because that just confuses everyone. It's certainly not textbook finance. I mean, it takes quite a bit of work to figure that out.
Ben Felix: That's really interesting. No pun intended there. Do we know why there's that racial disparity?
John Campbell: Well, it's a little hard to disentangle. Some of this is certainly that black borrowers may have more unstable incomes, so they may no longer qualify for the same mortgage rate that they were originally able to get. So there are those problems.
But we know that it's just systematically true wherever you look that people with less education and lower income, less financial sophistication, if you like, are slower to do these things. I mean, I have a study with Tarun and other coauthors where we look at the Danish mortgage system where you have an absolute right to refinance. It doesn't matter what your income is, what your house price is.
If you want to lower your rate, you can always do that. Even there, we find the same patterns that older people, less educated people, lower income people are slower to refinance and they leave money on the table.
Ben Felix: Moving on to a different topic here. One of the things we spent a lot of time talking to you last time you were on our podcast was utility theory. Can you talk about how utility as a concept informs sensible risk-taking?
John Campbell: Okay. That's another great question. We actually have a chapter on risk, living with risk.
I guess fools rush in where angels fear to tread. We try to use utility theory, this very academic concept, as a practical guide to both taking risk in investing and also how you should approach insurance. We try to explain how utility theory and its standard form, Bob Merton and things we talked about the last time I was on this podcast with you, how that standard utility theory leads to simple principles like, yes, you should participate in risky markets.
You should take some risk, even if you're very cautious. You can scale your risk by thinking about your risk aversion intelligently and investing accordingly. On the insurance side, we use utility theory to explain why you should, when insurance is marked up, so it's not actuarially fair because it covers the costs of the insurance company, you shouldn't try to fully insure.
You should accept deductibles and other things that limit your insurance. Essentially, you should insure the big risks and not sweat the small stuff. Utility theory is very clear about this.
Do not bother to insure small risks when there's markups on the insurance. Go for the big things. Make sure the catastrophes are covered and leave the small stuff alone.
We think that's really important advice because people so often do the opposite. They buy extended warranties on washing machines and then they don't buy catastrophe insurance or long-term care insurance, which are really huge risks in life. I don't know whether the chapter will work, whether it will be intelligible, but we felt it was important to try to show how utility theory can provide a simple, unified framework for making all these decisions that may seem very different, but underneath the hood, they're all based on the same principles.
Cameron Passmore: What are the most important principles for successfully investing in stocks?
John Campbell: Well, once you get past participate, which is just do it, then you need to ask how to do it. We talk about diversification. That's super important.
We show how diversification can reduce risk, leave the expected return very much the same. That means it increases the ratio of reward to risk, or so-called Sharpe ratio. That means you should invest more aggressively for any level of risk aversion.
We talk through that. Then we talk about the importance of watching the fees. For many people, they're not going to be necessarily investing directly.
They're going to be buying mutual funds or other intermediated financial products, which charge fees. You should be very mindful of those fees. They may not be as salient as recent performance, but they are for sure.
The recent performance may only not repeat. The fees almost certainly will. We emphasize that and we try to give the basic intuition of market efficiency that returns are hard to predict.
We say don't chase performance, focus on long-term historical evidence about rates of return, diversification, low fees. It's very much the classic advice of finance professors, but we try to make it readable and accessible.
Ben Felix: Participate in the equity markets, diversify, minimize fees, don't chase performance. Pretty timeless advice, I'd say. Important question though, empirically, how does actual investor behavior compare to those principles?
John Campbell: People ignore most of this advice. Many people do. We have problems on all fronts.
Participation is actually surprisingly low, even among people who have some substantial assets. We think one reason for that in the US context is that the tax favored retirement accounts, 401ks and so forth, that work so well for employees of big companies are much less available to people who work for small companies or are self-employed or jump from one job to another. So there's a real access problem there for the tax favored retirement investing.
That's one reason and we'd like to fix that. Then, of course, people are not as smart as they should be about fees. I will say there's some progress in the sense that the traditional active retail neutral fund that charges a percentage point of AUM, their assets have been diminishing and passive funds have been gaining share.
At the same time, of course, high fee, high octane active investments have been gaining share. Many of those are used by richer people, whether it's private equity funds, alternatives, hedge funds. But the latest trend now is active ETFs.
And while they may be lower fee than some of the traditional active neutral funds, they may simply be a newer vehicle for separating people from their money. I'm a little worried about what's going to happen with the rise of active ETFs for what I'll call naive investors. We know that performance chasing is still popular and sometimes it's encouraged by technology.
An example we give in the book is that in China, the smartphone app that many people use to shop for mutual funds, which is called Alipay, you bring up a screen on your phone and it sorts the funds by their performance in the last year. At the top of the screen is going to be whichever fund went up the most in the last year. That's typically going to be a very risky fund because if it weren't very risky, it wouldn't have been at the top.
We all know how easy it is to click on the thing that's at the top of the search list. And so this encourages performance chasing. We should admit that many people love to gamble.
There is actually a demand for gambling, whether that's casinos, whether it's sports betting. The latest is sports betting on the prediction markets, you know, Kelshi and so on, crypto. There is a demand for that.
And I think we need to accept that some of that is human nature. I'm not trying to be a Puritan that shuts down every source of fun that people have, but I do think it's important to distinguish gambling for fun from investing for your life and for your retirement and your lifetime risk management. I'm worried that people are not making that separation clear enough.
Ben Felix: Yeah, me too.
Cameron Passmore: What are the biggest insurance mistakes that people make?
John Campbell: Well, I've mentioned this problem of worrying too much about the small risks and not enough about the big ones.
One place where that plays out is in choosing a health insurance plan in the U.S. where it's a very complicated system. People have to make decisions. Every year, big employers will send out the new set of plans you can choose from and there'll be an open enrollment period.
You have to make a choice. Actually, one thing I do in my class is I take the students through the health insurance choices that Harvard employees have to make, and they get very confused. Then I say, you do realize that every employee of Harvard University, including the dining hall workers, have to deal with this.
That's sobering for them. But in any event, the problem that people often make is that they choose an expensive plan with a low deductible when they'd be much better off choosing a cheaper plan with a high deductible. One rather shocking thing is that it's surprisingly common for employers to offer a menu of plans where some plans are actually dominated, by which I mean there is no scenario, there is no level of healthcare costs in the coming year that would make the plan cheaper than the other one.
It's simply a plan that you should not choose. Nobody should choose. In my view, such a plan should not be offered.
Now, I don't think the employers are doing this for malevolent reasons. They're not trying to trap their employees. It's just that, first of all, the people who work in the benefits offices are often confused about this themselves.
Secondly, they're catering to employees who love low deductibles, even though the insurance companies make those low deductibles very expensive. Rather than try to explain to employees why it's a ripoff, they just say, all right, we'll let this be offered. Well, then what happens?
The poorer employees, the lower-paid people disproportionately choose these plans, and the better-off employees, the faculty and administrators, choose the better deals. That's another distressing place where inequality is worsened by the menu of choices that people are offered. But let me say, it's not just the people with the least education who are confused about this.
I remember going to a Harvard faculty meeting years ago where Alan Garber, who was then the provost and is now the president of Harvard, was trying to explain the merits of high-deductible, cheap insurance policies. Now, Alan Garber is one of the world's most distinguished health economists, but he could not get through to the Harvard faculty. People were shouting at him that, you're trying to take away our health insurance.
It was really quite an eye-opening lesson for me to watch that.
Ben Felix: That is a great story. Crazy. Okay, switching gears again here, how much do people need to save for retirement?
John Campbell: That's going to depend a lot on a number of features. For one thing, it depends if you have access to some kind of defined benefit pension. That's less and less common on the private side in this country.
In the U.S., public employees still often do have defined benefit pensions. It also depends on where you are in the income distribution because Social Security, which is our universal government-provided defined benefit pension, is progressive. If you're a relatively poor person, Social Security is going to replace a lot of your lifetime income.
If you're higher in the income distribution, it's going to be very inadequate. There are many special things you have to think about, but a rough rule of thumb that I think is worth keeping in mind is you should aim to have about six years' worth of income saved up when you retire. Fifteen years before that, when you're in your early 50s, you should have four years' worth saved by then.
The evidence is most people do not save that much. Even in a good year where the markets have been doing well and people have pretty good 401k balances, a good year you might see four years of income saved at retirement on average instead of six. Now, some people have a lot of housing equity.
You're likely to be okay if you actually have a house and you paid off the mortgage. That's going to make things much more comfortable. But anyway, significant saving would be the answer, more than most people are actually doing.
Cameron Passmore: And how should retirement savers allocate their investments?
John Campbell: I believe that you should think about lifecycle investing very much the way target date funds do. So target date funds are a good innovation that has been spreading in the last 20 years. And what they do is they have young people investing more aggressively than older people.
Why is that? One reason might be that if you're investing for the long run, you can benefit from mean reversion in the stock market. That's something we talked about the last time I was talking with you on Rational Reminder.
But I think the bigger reason, honestly, is that young people have a lot of earning power. They have an implicit asset, which is their human capital or future earning power. And while that's risky, of course, you don't know how much you'll make.
It's much, much safer than the stock market. Young people have a relatively safe hidden asset. And what they're doing over their working lives is gradually converting that hidden asset into explicit financial assets.
Early in life, you should invest very aggressively because you're investing only a small portion of your total resources. And then by the time you approach retirement, you're investing almost all your total resources, and you should invest more conservatively. So target date funds do that, but there are some problems with the ones that exist.
They don't decline risk-taking aggressively enough. They start out a little too cautious, and then they decline gradually. The tilt should be steeper.
Target date funds should also, ideally, should condition on how much you've saved already. It's about the size of your financial assets relative to your earning power. It shouldn't just depend on age.
It should also depend on how much you've been saving and how well the market has done and so forth. But that basic pattern is what I would recommend. And I think, given the long life that people should expect to have in retirement, the type of risk aversion that I think most people have, I think you should continue to take some equity risk even in retirement.
Although you should start to think about annuitization. That's another important investment topic when you reach retirement.
Ben Felix: We've tried talking to our clients about this, and they don't tend to be very receptive. Why do you think annuities are not more popular? You just said, as the classic finance professor, people should buy annuities, and they don't. Why?
John Campbell: Why? I think people like to feel control. They like the sense that they control their financial assets.
They don't like the sense that they're handing a lot of money over to an institution that, under certain circumstances, will pay you back. But that's years from now. I think there's a marketing and perception problem.
And part of the problem is people think of an annuity as an investment when you should think of it as an insurance product. And following the principle we discussed, that you should ensure the large risks, not the small ones, I would say that deferred payout annuities should be more common. So you retire, maybe you're 65, 67, 70.
Whenever you retire, instead of thinking about an annuity that starts paying out immediately, think about a much cheaper annuity that will start paying out when you, say, turn 85, if you do. That's going to ensure you against extreme long life, living into your 90s, even your 100s. And it'll be more affordable, and you can retain control of much of your wealth in the meantime.
Ben Felix: Framing it that way might help. There are a couple of products that, I think one of them still exists, one of them failed, I believe, that were kind of modeled after tontines, but they were mutual funds that you could invest in, so you still had control of the assets. But there are these mortality credits that accumulated.
Really cool idea, but total flops from a product perspective. It didn't gather any assets. We've touched on this a little bit earlier, but what role do you think technology has played in improving access to finance for ordinary people?
John Campbell: As we were saying earlier, it's lowered the costs of small-scale products. Small investors can do things like taking out small loans or trading small amounts of stock at a lower cost than they would have been able to before. And it provides a new and much more convenient interface that you can use to accomplish financial transactions and to shop around.
It's certainly made some things better. The problem arises because you can also use the attractiveness of the interface to gamify bad things, like day-trading stocks, for example. If you're doing it on your smartphone, and it shows you confetti falling when you make a trade or you sell at a profit or something, that's going to be fun, but all too fun.
It's going to lead you down the wrong path. I think we also have to be very mindful of the fact that technology enables very sophisticated price discrimination. You're going to be shown a price that may depend on your online profile and all the data you've inadvertently revealed by using the internet and social media.
If you look like somebody who shops around, you'll be offered a good price. And if you look like somebody who takes the first deal you're offered, you'll be offered a rip-off price. And so that's actually very troubling.
Cameron Passmore: What are the potential risks of the expansion of fintechs?
John Campbell: There are the consumer risks that they exploit our psychological biases in a more sophisticated way, or they discriminate algorithmically. That's on the consumer side. Then on the financial system stability side, you've got to worry about financial activities that migrate outside the regulated system and move into a parallel system that's unregulated, where we could have a financial crisis blow up.
Certainly, the creation of a parallel crypto system is one place where we see that happening. So far, the problems with the crypto ecosystem have been small enough that big disasters like FTX and so forth have not really jeopardized the mainstream financial system. But if we let crypto rip, and let's say many people start to rely on stablecoins as a place to keep their emergency funds, and the stablecoin issuers are not sufficiently regulated, and they start to make risky investments, you can then have a bank run, and it's all unregulated.
It's like the financial system before the creation of the Federal Reserve and the FDIC in this country. So we should certainly be worried about that.
Ben Felix: What do you think are the main lessons from crypto and DeFi so far? Those systemic risks that could happen aside, what do you think are the main lessons from what has happened to date?
John Campbell: Well, I've certainly learned that there's a huge appetite for these types of financial products. I used to think that it was purely an appetite for speculative investments. But the recent growth of stablecoins is a very interesting phenomenon, because stablecoins are not speculative investments.
They're like bank deposits. They typically pay no interest, and yet the issuers are earning interest. There's a huge deposit franchise there.
So firms like Circle and Tether are making enormous profits, especially now that treasury bill rates have come up. So why do people like stablecoins relative to traditional bank accounts? I'm still trying to figure that out.
Maybe it's that they want to have liquid funds that they can use to invest in crypto when they feel like it. Maybe it's distrust of the traditional banking system, sort of disillusionment. But I think understanding the source of the interest in the market demand for stablecoins is an important research topic. I don't think we fully understand it yet.
Cameron Passmore: How do you think regulators can both allow innovation at the same time protect consumers?
John Campbell: It's a tricky balance. I think we should be very much in favor of innovations that automate traditional procedures, that take things that were done slowly and inefficiently and do them more quickly and more efficiently. There are certainly improvements in the payment system that we needed to see, whether that's Venmo, whether it's Zelle, whether it's WISE, which is focusing on international payments.
The traditional banking system was extremely slow. There are some countries like Brazil, which are introducing very efficient government-provided digital currencies. So there, what you're doing is you're taking something that was notoriously slow and inefficient and you're speeding it up.
I don't mean to say let that rip, but certainly encourage that. I think regulators should be more cautious where somebody says, I'm going to do something completely new and it's never been done before, but I'm going to do it. I think they're trying to allow small-scale experiments, study them and see how they work, and then relax the regulation once you have a proof of concept.
I think that's the way to go. One thing that I regret about the Trump administration assault on the Consumer Financial Protection Bureau in the U.S. is that the CFPB was doing a lot of useful research on how financial products are actually used, and that was a valuable source of information that could inform good policy. So I think shutting that down is a bad idea.
Ben Felix: More generally, I mean, we've talked about a lot of the mistakes that people make, the decisions that they maybe should be making if they were perfectly rational, and we've talked about how capitalists, financial companies, whatever it may be, are pretty good at capitalizing on those mistakes and maybe even pushing people away from what is normatively optimal. What role do you think government should be playing in improving how those parties interact and improving the financial system?
John Campbell: Okay. So this is the whole last part of our book where we talk about what can be done. We start by acknowledging that governments should try to get the basics right.
There are some very basic government functions like providing financial infrastructure, the payment system, efficient electronic ownership registries, things of that kind. So we shouldn't forget about the basics. Governments also obviously have a role in regulating, if you like, channeling the flow of information.
Financial information can be thought of as a public good. So things like the credit reporting system and the disclosures that need to be made concerning credit products. I mean, this is a very traditional function going on in the US going back to things like the Truth in Lending Act, which is from the late 1960s.
So we should do all of that. But we think, Tarun and I think, that more is needed. It needs to go beyond the light-touch intervention that's sometimes called nudge.
Nudge, if you remember, was a And their idea was that government could either provide information, suggestions, or maybe go a little bit further and provide a default choice that you would give consumers, but then people would be able at almost no cost to opt out. And so that's sometimes called libertarian paternalism. You're trying to do something in people's interests, but you're libertarian because you let them opt out at a minimal, minimal cost.
So nudge was very popular for a while, very fashionable idea. Lots of governments around the world created so-called nudge units to study doing this in different contexts. But we argue that as the researchers come in, what we've learned is that nudges often have short-term effects that look promising, but then over time, the effects dissipate.
So if you take auto-enrollment in a retirement savings plan, yes, you can get people to sign up more if you auto-enroll them. Over time, the difference vanishes. The people who weren't initially auto-enrolled, they may be slow, but they eventually sign up.
And the people who were initially auto-enrolled, maybe they changed jobs and then they take the money out. That's a form of leakage. So if the ultimate goal is to get adequate retirement saving, it turns out that nudges don't work as well as was initially advertised.
So we argue that governments need to go further, and we call this shove, be more aggressive than nudge, actually give the system a shove. And what we mean by that is we think governments should focus on product design. We've talked a lot in this podcast about good product design versus bad product design.
And we think that regulators, there needs to be a consumer financial regulator, a single body that focuses on this aspect of the financial system. And it should be forward-looking and it should say, look, a good product would look like such and such. Let's make sure that the good product is available.
Now, how do you do that? We argue that in each segment of the financial industry, there should be a simple product. We call it a starter kit product that people should naturally start with.
And the regulator should define the terms of the product, not set the fees necessarily, but define the units in which the fees are expressed and the terms and conditions. And financial firms that are active in that segment of the market, they can offer other products. We're not trying to shut off innovation, not trying to tell them what to do, but they must offer a product in this category.
And the idea is to make it safe, easy to use, and easy to shop for. That's critical because if people understand the pricing units, they will be more likely to shop on the basis of price. So we make the analogy with over-the-counter medications.
In the modern regulated healthcare system, there are certain products that are simple enough that people can just go into the pharmacy and buy them, and they're efficacious, and they are sold on the basis of price. So you have a headache, you go into the pharmacy, you look on the shelf. You can buy Advil or you can buy the generic pharmacy brand.
The bottles are right next to each other. The size of the pill is the same, in each case you take two pills. The price per pill is on the shelf and you can shop.
Maybe you like the brand, maybe you want to save money, but it's easy to shop for. And so price competition, which we were talking about earlier, actually works in that environment. So we think this can be done with financial products as well.
Cameron Passmore: Where is the line where regulation has gone too far?
John Campbell: We think there are two temptations that governments need to avoid. So one temptation is to have a vague consumer duty which amounts to imposing fiduciary duty on the whole financial system. This is where you say, and the FCA, the Financial Conduct Authority in the UK, at one point moved a little bit too much in this direction, I think.
You basically say to the big banks and other institutions, you need to treat your customers right, and we will decide whether you've done that. And if you haven't treated them right, we're going to come in and fine you billions of pounds or billions of dollars, and also shame you publicly. But we're not going to tell you in advance what misconduct is.
And understandably, businesses hate that. They want to know what the rules are so they can follow the rules. But a sort of consumer duty or fiduciary duty on the whole industry is too vague.
And what it will produce is a kind of safety culture that's very dominated by lawyers and sort of cover your ass and you'll choke off innovation. And it'll be expensive. So there's a backlash against this now, particularly in the UK, there's a backlash.
But I think part of what the Trump administration has been doing is also a backlash against this. Now, the other thing that we think governments shouldn't do is get directly into the business of financial service provision. Certainly in the old days, there were things like postal savings offered by post offices.
There are certain functions that governments do directly, like hand out student loans in the UK and Australia. That's a direct government function. There are one or two exceptions.
But basically, finance today is an IT business. It's a big, complicated software product. And governments are notoriously bad at running big, complicated software projects.
You go over budget. The thing doesn't work when it's rolled out. The reform of healthcare, of Armacare in the US, it almost collapsed when the healthcare.gov website didn't work when it was first rolled out. You have scandals in the UK. There's the infamous Horizon scandal, which is the British post office that had accounting software that wrongly identified fraud by a number of the post office franchisees. A terrible scandal.
I mean, people were unjustly accused. There were people who killed themselves. This was the result of a big government agency buying accounting software from a big company, rolling it out, not monitoring it, and assuming it was correct when it wasn't.
So the track record of direct government administration of big IT projects is very poor. We would say governments should stick to a few things, maybe student loans. The social security system in the US works well.
Let's sort of stick to your knitting and don't try to take over the financial industry. So we contrast our proposals with that. We say, have limited regulation that specifies certain products that should be offered, enforce the offering of those products, and leave it at that.
Ben Felix: What specific areas do you want to see, like you mentioned the shove, what specific areas do you want to see more forceful regulation in?
John Campbell: Well, we think retirement accounts. We think they're, certainly in the US, the main problem is access. So we'd like to see, for example, the creation of a universal retirement account that is opened when you first start working and that you can carry with you your whole life without all the complicated rollover provisions that exist now.
And that's actually an area where we think people should be required to choose one. So we don't always advocate that, but in important cases, we think it's okay to go that far. We think that transaction accounts could also be reformed.
The current system confuses people who don't understand interest, and they think they have free checking. They're actually paying it by losing the interest. So we think that transactions accounts should pay money market interest rates, but then charge explicit fees that come out of the interest.
That will allow them to adapt automatically to changes in market rates, but also make the fees more salient to everyone, and then people will shop around and find the lowest fees. So certainly retirement accounts, transactions accounts, but also insurance products. That insurance is a big industry, and it covers a multitude of things from catastrophe insurance against natural disasters.
This is more and more important in the world of climate change. Everything from that to annuities, which we discussed, life insurance. We have a lot of ideas, and it would take too long to go through them all.
What we do in the last chapter of the book is we march through the financial system, prescribing many, many of the products where we've seen problems and suggesting some solutions.
Cameron Passmore: What main principles would you follow in designing a better financial system?
John Campbell: We come up with four principles. They sound a little bit like four of the Disney seven dwarfs, I have to say. We call it simple, cheap, safe, and easy.
Easy, not sneezy. Those principles reinforce one another. Simple makes it easy to shop, so that will promote cheap.
Simple also makes it easier for people to manage, so simple will promote easy. People will be less likely to make mistakes if a product is simple, so that will also help with safe and so forth. We think these are reinforcing principles, but those are what we have our eye on.
Ben Felix: Very nice set of words of principles. You alluded to a starter kit of financial products earlier. What goes in the ideal starter kit of financial products in your view?
John Campbell: First of all, a transaction account, which I was discussing a few minutes ago. Secondly, a savings account, which can be used for things like receiving tax refunds and helping to build up an emergency fund. Third, a retirement account, which can be used to start risky investing.
Then fourth, a set of suitable insurance products, which are going to be linked to where people are in the life cycle and people's needs. Now, of course, within these different accounts, you can also have other financial products like target date funds, which I was talking about earlier. We also think that credit availability is important for the cases, the situations where people do exhaust their emergency funds.
We think the principle there is that it's important to link credit to people's ability to repay. So credit shouldn't be linked to your desire to spend. We're not in favor of buy now, pay later credit because that encourages impulse spending.
We are in favor of paycheck advance programs, which make the timing of when you get your paycheck a little more flexible because that's tied to your employment and hence your ability to repay. We also think that it's desirable to allow people to borrow in certain circumstances against the value of their retirement account, but that has to be very carefully structured.
Ben Felix: You and Tarun have put together really an incredible analysis of the financial system, of its shortcomings as it exists now, and some proposed solutions. You've written the book, obviously, but where does something like this go next? How does this stuff actually happen? How will the two of you measure the success of your efforts?
John Campbell: You know, where we're going next is trying to talk a lot about the book and trying to get the media to pay attention. I'm grateful to you for having me on Rational Reminder, but I'm trying to do a lot of these things and so is Tarun. We're trying to get the world to pay attention.
It's obviously a very noisy world with a lot going on, so it can be hard to get that attention, but that's our first move. Now, in terms of implementation, we're realistic about the fact that there's a political cycle. I don't think it's realistic to expect any kind of financial regulation really in the next couple of years in the US, given where we're at.
As I mentioned, we take a global perspective. Different countries are at different places politically, and there may be many places where some actions along these lines can begin to happen, but we hope to have a gradual long-term influence by putting clearly in people's minds what the goals of financial regulation are. Again, it shouldn't be about coming in and saying to the financial industry, you've been bad.
We're going to punish you because you were bad. One problem is that a lot of consumer financial regulation came in after the global financial crisis, at a time when lots of people had this vague sense that the financial industry was bad and should be punished. That's not at all what we're talking about.
We're talking about design, intelligent design, and we hope that by getting that in people's heads over time, good things can happen. Now, how will we measure that? Well, that's what the academic field of household finance does, a field of research that's developed a lot in the last 20, 25 years.
It's a big part of academic finance today, and I think it's very valuable research. It's fascinating, but it's also practically important. We now have ways to measure all kinds of different outcomes.
How many people are letting their insurance policies lapse at just the wrong moment? How many people have not saved enough for retirement? How many people are buying dominated health insurance plans?
How many people are paying multiple overdraft charges on their bank accounts? Or how many people are paying late fees on credit cards, even though they're paying more than the minimum on another card, and so they could obviously afford to avoid the late fee. We can measure these sorts of things, but we can also measure price dispersion.
Another place we might look is we might look to see how many expensive rip-off index funds are being offered. An index fund is a standardized product. If you see an index fund being sold with a fee of 50, 60, 70 basis points, that's too much.
That should not be able to survive in the marketplace. There's a lot of research. I think it's a very valuable function of the academic finance community to study this stuff and write papers about it.
Then maybe every now and again, someone will come along and write a book to summarize it. I don't know if I will have another book in me, but if not me, then perhaps somebody else will write the book in a few years so we can see what progress we've made.
Ben Felix: Did you kick off the whole field of household finance with your presidential address for the American Finance Association?
John Campbell: I wouldn't claim to have kicked it off. I would claim to have seen a trend and labeled it and encouraged it. The work was happening.
It was a bit scattered. People didn't necessarily see how it fit together or where it was headed. So I tried to pull things together, and I gave the talk a name that was then picked up as the name of the academic field.
Within academia, we talk about household finance. We have household finance conferences. But in the outside world, we might talk about personal finance.
That's part of the title of our book. The course I teach at Harvard is called Personal Finance. Then people also talk about consumer finance as in the Consumer Financial Protection Bureau.
So different words are used. I was really trying to label what was emerging and encourage it, and I think I achieved it. But I would certainly not claim to have kicked it off.
Ben Felix: Even still, the fact that you maybe gave it a name and put people in the same direction, started moving people in the same direction toward what has become a pretty significant field of study makes it quite fitting for you to have written this book, which again, is kind of tying the whole thing together and showing, here's what we know from all this research that's happened since then, and here's what we can actually do with it.
John Campbell: Great. Well, thank you. I'm glad you liked the book, and I really enjoyed being able to talk about it. So thank you for having me.
Ben Felix: Awesome. Thanks a lot, John. This was great.
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