In August 2003, my wife and I were finally returning to the United States, after living in London for six years. We had been back in the country less than 24 hours, when I made the dumbest financial mistake of my life.
In an utterly irrational moment of impulsiveness, I lost $16,500 in a failed real estate transaction. I was unemployed at the time, too, so it was a huge loss for me. For many months afterward, the loss was unbearable. With the passage of time, however, I've been able to learn several invaluable financial lessons from the debacle.
This time is different
The housing market in the Washington, D.C., area was on fire in the summer of 2003. Home prices had been increasing around 16% per year in real terms during the prior four years, and many middle-class families could no longer afford to buy a home in the region. Nationally, of course, housing prices had already begun their steep upward trajectory by 2003, as the following chart from Zillow indicates.
In retrospect, the overheated market should have made us pause. In reality, it had the opposite effect. Houses back then didn't stay on the market very long. If you wanted one, you needed to act quickly. The real estate market in 2003 was no place for deliberating.
We had had some experience with the housing market in the months prior to our move to Washington. We had actually made a couple of unsuccessful offers on homes in the D.C. area, while still residing in London. Our big takeaway from those initial forays was that we'd need to be quicker than the competition in the future, and might have to pay a premium for something we really liked.
The lost weekend
The first 72 hours back in the U.S. were somewhat of a blur. We landed at Dulles Airport on a Friday afternoon. On Saturday morning, we saw a beautiful home in Cabin John, Md. Despite not having an agent representing us, we made an offer that afternoon, and it was accepted later that evening. On Sunday, we filled out some paperwork and handed over a $20,000 check for the earnest money deposit to the seller's agent. On Monday, we met with a mortgage broker to figure out how we were going to pay for our dream house.
Yes, I realize there are a few absurd errors of judgment mentioned in the above paragraph. First of all, we should have had our own agent. Second, we should have met with our mortgage broker before we actually made an offer and handed over the earnest deposit. Finally, we should have taken a couple of days to think about whether we were ready for such a big financial commitment especially since neither one of us had landed a job yet.
Looking back 10 years later, I still can't comprehend our stupidity. Sadly, I can't even plead ignorance. I was surprisingly aware of what we were doing at the time.
I majored in economics as an undergrad, and was very familiar with the basic principles of finance. I knew all about the dangers of debt and variable interest rates and the possibility of a fall in housing prices. I was particularly aware, in fact, that our financial situation was not quite yet strong enough to afford the home we were considering. Despite all of that, we went ahead and bought it anyway.
As you might expect, the meeting with the mortgage broker was a rude awakening. He told us that we likely wouldn't qualify for our desired 30-year, fixed-rate loan. But he consoled us by saying he was sure he could get us a variable-rate loan. In time, we'd probably want to refinance, but for now, he was pretty sure he could get us some sort of mortgage.
At some point during the meeting, the grim reality of our situation finally dawned on me. I knew we couldn't afford the house, and I was certain we didn't want an adjustable-rate loan. Finally, I didn't want to purchase a property until at least one of us had a stable job (gee, you think?).
After a sleepless night, we both decided to stop the madness. We called the seller's agent and told her we had made a horrible mistake. We apologized profusely, and asked if the buyer could possibly forgive our recklessness, and return the deposit, since it really was sort of a no-harm, no-foul situation. The seller said no. If we wanted to walk away, we would have to forfeit the entire $20,000. Eventually, they softened a bit, and gave us back $3,500. The bottom line was a $16,500 loss along with a couple of sleepless nights. And no dream house.
What is the price of experience?
Perhaps the only good thing that came out of the fiasco is that it taught me a lot about myself and investing. Here are three lessons.
1. If it's broken, you need to fix it
Clearly, my wife and I had done something extremely dumb, and we needed to make sure it didn't happen again. Ever since that disastrous episode, we've taken more time with our financial decisions and have subjected them to greater scrutiny.
In Thinking, Fast and Slow, Nobel laureate Daniel Kahneman talks of System 1 thinking and System 2 thinking. System 1 is the quick, automatic thinking that we were using that day to purchase that house in Cabin John, Md. We knew we wanted something special, and knew we'd have to act fast. What we needed more of, however, was System 2 thinking, which requires concentration, reason, and deliberation.
In recent years, my wife and I have worked on becoming more deliberative and thoughtful with our financial decision-making process. And just four years after our mistake, we were able to buy a nice home in Washington, D.C., with a very reasonable 30-year, fixed-rate mortgage.
2. Emotions play a huge role in financial decision-making
In our marriage, my wife tends to be the risk taker, while I'm usually the prudent one. Alas, that particular weekend my conservative financial outlook abandoned me temporarily. For those 72 hours, my emotions took over, and it resulted in a very poor decision.
With hindsight, it's somewhat more understandable to me. Three years prior to returning to America, my mom had passed away, and my sisters and I had to sell our family home in central Massachusetts. After the sale, while living in London, I had felt rootless, and noticed a strong desire to purchase a home for my new family. Once we arrived in D.C., my determination to buy a home was so intense and all-consuming that all other considerations seemed unimportant -- at least for a while. By the time I came to my senses, it was too late.
The lesson here is that emotions can be extremely powerful, and each of us needs to be more aware of how they might be affecting our financial decisions. Everyone knows very smart people who do very stupid things with money. Many times it's because we think we deserve the Ivy League education regardless of its costs, or we just know the IPO shares will ultimately provide us with the financial security we've been longing for.
It's not rational, of course, to feel this way. That's what makes it so dangerous to our finances. As Helaine Olen, author of Pound Foolish, points out, "when it comes to money, the vast majority of us are nuts."
3. There will always be regrets
The final lesson might be the most meaningful one for me. Having regrets about losses is a big part of investing, and investors need to embrace their regrets rather than trying desperately to avoid them. If you cannot bear to have anything go wrong, then you should definitely steer clear of investing.
In an inspirational TED talk, writer Kathryn Schulz talks about the idea of regret, and how central it is to our lives. Unlike Lady Macbeth, who consoles herself by saying, "What's done is done," we should attempt to better understand our regrets, so we have a better sense of what went wrong. Schulz concludes her wonderful video by saying, "Regret doesn't remind us that we did badly. It shows we can do better."
That's exactly how I choose to remember the biggest financial mistake of my life. I had an understandable desire for a new home, and then had a momentary lapse in good sense, which resulted in a very painful loss. Overall, I'd say my wife and I learned some valuable lessons from the ordeal, while also learning to live with the loss in the end. It still stings, of course, every time I drive through Cabin John, Md., but fortunately, it stings less with each passing year.