Learn by These Mistakes
Sunday, December 3, 2006
When it comes to money, we all make mistakes -- sticking with a dog-of-a-stock too long, taking too little risk (or too much), buying a house that's too expensive, drinking overpriced designer coffee. The list goes on.
Even the most accomplished among us has made a memorable financial blunder. We asked a handful of successful people for their biggest mistakes and what they learned from them. Our respondents -- real estate investor Joe Robert, radio personality Diane Rehm, investment banker Herbert Allen, baker Warren Brown and novelist George Pelecanos -- obliged with examples that ranged from incidents that cost a few hundred dollars to several million.
Their stories bear out what the experts say: Anyone can make a mistake with money. Financial planners say most miscues stem from failing to take a big-picture look at your finances that should tell you what you can afford, what your goals should be and what steps you can take to reach them.
Instead, planners say, too many people act on impulse. "Usually when you make decisions on those emotions rather than on rational principles you know work over the long run, that's when you get into trouble," says financial planner Annette Simon, co-founder of the Garnet Group in Bethesda.
Financial planner Greg Fernandez of McLean says the smartest people are prone to error precisely because they're so brainy. "Their egos get in the way," says Fernandez. "They can't stand losing, and that makes it worse. Once they lose money, they become more wedded to whatever it is; they can't believe they are losing."
He tells the story of a doctor client who created with a group of other doctors what they thought was a sure-bet software program to profit from the tricky business of buying and selling commodities.
His client eventually lost a bundle, but far more than he should have because he didn't admit soon enough that the program had in fact not outwitted the market. Once he owned up to his error, however, he compounded it by letting his fear of repeating that mistake keep him out the stock market completely for several years. That overcompensation for the original mistake meant that he lost out on gains he could have made from prudent investing, Fernandez says.
The best way to avoid making a mistake with your money is to follow a few basic rules, financial planners say. Those include: think for the long term, keep your investments diversified, resist temptation to chase after a hot stock, know how much risk you can tolerate, and never invest more than you can afford to lose.
Brad M. Barber, a finance professor at the University of California at Davis who specializes in investor psychology, says a common error people make is to judge the wisdom of a decision by its short-term outcome, which could have occurred by chance.
For example, having most of his money invested in a stock that takes off might tempt an investor into thinking his decision was good, when in fact, most money managers would argue that the gains don't outweigh the risk of losing everything if that one investment sours.
"Don't throw out wise rules if you do well on something," he says. "There's that old Wall Street adage: Don't confuse brains with the bull market."
And if you do slip up, experts recommend moving on quickly and not getting tied down emotionally. Admitting a mistake is the most important step, financial experts say. Evaluating options to correct it or get out of it -- and getting enough information about those options -- is the next.
"Don't just react," says Steven Thalheimer, a financial planner in Silver Spring. "It's probable that an emotion-based reaction got you into this situation, so don't try to get out of it based on emotion alone."