Author: Chuck Saletta | February 26, 2019
Everyone makes mistakes
Nobody is born a financial expert. Even Warren Buffett -- who is generally regarded as among the best financial minds in the modern era -- was trained at the hands of Benjamin Graham, the father of value investing. So it’s okay if you’ve made a few financial mistakes in your life. We all have.
Still, a key part of improving your financial status over time is to learn from mistakes. It’s one thing to learn from your own and improve, but it’s even better if you can learn from someone else’s and avoid making the same ones yourself. With that spirit, I'll share these eight financial mistakes that I’ve made in my life, in the hopes you can steer yourself to a better spot.
No. 1: I bought too much of a first home
While my wife and I were engaged, we went house hunting together. I ended up buying a great house in a great neighborhood in a great school district that was close to both of our offices. It was a stretch on my own, but I figured that after the marriage we’d both be working for at least a little while, and with the switch to two salaries, we’d be able to make ends meet and set it up comfortably. Silly me.
Life got in the way of those plans. My wife quickly become pregnant with our first child, my work moved me to a farther away office in a more expensive location, and major appliances like the water heater and air conditioner broke down. What was a stretch on my own became an even bigger stretch when I was working to support three of us and the act of working started to cost several hundred dollars a month more than I had anticipated.
It took several years of me working a second job before we were able to dig out of the hole we got ourselves into by stretching to buy that first home. Were I to do it all over again, I would have bought a substantially smaller house in a similar neighborhood and saved us a lot of trouble and stress.
No. 2: I over-saved inside my traditional retirement account
Part of the reason the house was such a stretch was the fact that I had been dutifully socking away money inside my employer’s traditional 401(k) since about the time I first became eligible. The good news there was that I had a decent start on a great nest egg even before we went house hunting. The bad news was twofold. First, that money wasn’t accessible (without a huge tax and early withdrawal penalty cost) to help cover our costs when things started getting tight.
Second, as that money continued to compound and get added to, it eventually became apparent that we were setting ourselves up for some major costs once we did reach retirement. Typical withdrawals from traditional retirement plans are treated like ordinary income, which can make Social Security taxable and raise Medicare Part B costs. When combined with the mandatory withdrawals that traditional retirement accounts have after age 70 1/2, those higher costs would be tough to avoid.
I started working before the advent of Roth 401(k)s, so I didn’t have that option at that time. Were I to start over today, I would invest in a Roth 401(k) instead of a traditional one. If I could go back in time and give myself advice, I would have recommended shifting some of that money to an ordinary investment account and just labeling it as “for retirement.” That way, I wouldn’t have had more cash readily available if we really needed it and wouldn’t be at risk for quite as high costs in retirement.
No. 3: I ended up tapping that traditional retirement account early
A few years ago I had the opportunity to relocate for a promotion at my day job. That relocation moved us to a much higher cost of living part of the country. Learning the lessons from previously overbuying a house, we moved to a substantially smaller house than the one we left -- albeit still a more expensive one due to its location. The plan looked like it would work, until we discovered the house wouldn’t be in the top tier school district we thought it would be when we were house shopping.
As a result of that issue, we ended up scrambling to send our kids to a private school to assure they could get decent educations. Unfortunately, that meant an even higher cost of living than we had been planning for -- and even more than we could cover on just my salary. With nearly all our assets tied up in home equity or retirement accounts, we made the very expensive decision to tap our retirement accounts to cover the part we couldn’t cover from salary alone.
If we could do it again, we would have bought the house we didn’t like quite as much, but which was squarely within the better school district in town. Alternatively, had we known how long that role would end up lasting, we would have either borrowed enough to cover the tuition gap or paid the costs to move ourselves into the better school district.
No. 4: I didn’t pay enough attention to companies’ balance sheets
During the financial crisis, I was gleefully buying shares of financial companies’ stocks while they appeared to be on sale. While we pulled through in the end, deep in the crisis I made the mistake of assuming that companies with decent past earnings would eventually recover on the potential of that strength alone.
Unfortunately, I learned the hard way that when the going gets tough, companies still have to be able to get their hands on cash when they need it -- regardless of their longer term prospects. I saw companies I owned go bankrupt because they were over leveraged with some bad investments, rather than because their long-term business model was broken beyond repair.
While I lost money with that mistake, it did cement in my mind the importance of balance sheet strength in investing. I now look for companies with reasonable debt to equity ratios and current ratios that indicate they have sufficient immediate liquidity.
No. 5: I paid cash instead of taking out virtually free financing for a car
In April 2009, I wrote a check for around $31,000 to buy a new minivan. Doing so drained our cash reserves, but it allowed us to own a brand new vehicle with enough seats to cover our expanding family without taking on more debt. On the flip side, however, at that time dealers and car manufacturers were offering virtually free financing.
Had I taken advantage of that cheap financing and instead invested the $31,000 in stocks, it today would be worth somewhere around $125,000. Even if I hadn’t kept it invested that entire time period, it would likely have been enough to keep us from having to tap our retirement account to get the money to help cover our kids’ tuition costs. Instead, today that money is worth maybe a few thousand dollars in the form of a nearly decade old and seriously depreciated minivan.
No. 6: I relied on dividends to help cover cash flow needs
When I tapped my traditional 401(k) early, I did so by turning off dividend reinvestment and then having those dividends paid out to my checking account. Tapping dividends to cover spending needs is a strategy that looks reasonable on the surface, until you recognize the reality that dividends are not guaranteed payments. When a dividend gets cut, the stock often falls. That takes away both your income stream and much of the capital you otherwise could have used to generate income elsewhere.
I got lucky that I didn’t face that double whammy during the time I needed to tap my retirement account to cover my costs of living. Still, just because I got lucky doesn’t mean it’s a smart move to make. Instead, what I should have done was set up a bond ladder and use the maturing bonds to cover the tuition payments I couldn’t cover from my paycheck. That would have given me a cash flow stream with a much higher likelihood of success, due to bond payments taking priority over stock dividends.
No. 7: I mistook luck for skill with options
Shortly after I started attempting to use stock options as an investment tool, I had a banner year where I essentially doubled the money in my options account. Unfortunately, I faced some nasty tax consequences from that short run of success. In addition, I also soon learned the painful lesson that margin cuts both ways, particularly when combined with the leverage inherent in options.
That gain largely evaporated due to forced liquidations during margin calls as my positions began moving against me, leaving me with that tax headache but not much else to show for my risks. While I still see the potential benefits in including options in my investing strategy, I now recognize the risks better. As a result, I have have both dialed back my use of leverage and included less volatile investments in that account.
No. 8: I thought I could make a fortune as a “cigar-butt” investor
I’ve always admired the value investing strategy pioneered by Benjamin Graham that made his pupil, Warren Buffett, fabulously wealthy. When I first started investing, I thought I could follow directly in Graham’s footsteps. Following his ‘cigar-butt’ strategy, I started looking for discarded stocks that were trading so cheaply that they’d be worth more than their market value even if they were liquidated.
What I failed to recognize, however, is that in these days of computerized trading and online information disclosure, information travels much more efficiently than it did in Graham’s era. As a result, stocks that are trading at apparent cigar-butt valuations are far more likely to deserve those prices than they were in Graham’s day.
Unfortunately, many of my cigar-butt investing attempts ended up evaporating in a puff of smoke. I still believe in the power of valuation. These days, however, I’m much more apt to follow Charlie Munger’s advice and look to buy great companies at good prices rather than seeking out great prices on troubled ones.
And now the good news: Despite mistakes, we’re still on track to wind up okay
Although I’ve made my share of money mistakes, my wife and I remain on track for a comfortable retirement. This is because a reasonable investing strategy, executed regularly over time, drives a far better outcome than not investing at all.
What this means for you is that if we can find a path to wind up okay despite my mistakes, you can put yourself in an even better situation by simply not repeating them. The key to success, however, is to give yourself the most time possible for your investing to compound on your behalf. The sooner you get started, the more time you have to recover from any mistakes you may make along the way. That holds true whether you make the same ones I’ve made or if you wind up making different ones on your own.
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