We have all been there, you make a bad financial decision and realize later on that it’s going to cost you big time, but the worst case scenario is when you hang on, and red flags are right in front of you, telling you that its time to exit, but you still insist on hanging to your investment in the hope that the situation will reverse. Every investor has made a bad call more than once in their lifetime, which resulted in a loss on their part, but the big difference is how soon you to exit the position in order to minimize total losses. There are common mistakes that investors make, and the following article by Sheyna Steiner gives 5 bad financial decisions that investors make, and how to recover from them.
Everyone makes a bad financial decision at some point. Whether your mistake is hanging onto a stinker of a stock for too long or stumbling into a black hole of credit card debt, recovery is possible.
One of the most important aspects of the salvage mission is having the ability to learn from past mistakes.
Though this list is far from comprehensive, it outlines some frequent missteps consumers make as they navigate their finances.
Confusing Long Term With Short Term
There are active management strategies, in which a preset event triggers a decision to buy or sell. And then there is random flailing. That would be the strategy in which investors randomly sell positions after losing money and then buy back in after the market recovers.
“One of the biggest mistakes is when you start looking at your long-term investments as short-term,” says Carlo Panaccione, founder and president of the Navigation Group in Redwood Shores, Calif.
That’s most likely to happen “when people decide I’ll get out (of the market) until things look better. But by the time things look better, the market has already recovered,” he says.
How to recover: If you’ve jumped out of the market, dollar-cost average your way back in. Dollar-cost averaging involves investing a set amount of money on a regular schedule, regardless of market moves.
“Put in a little bit every month over 12 or 24 months. If the market goes up, you’ll get some of the upside. And if it goes down, you’ll buy it cheaper,” says Panaccione.
If market volatility will worry you in the future, meet with an investment adviser to devise a plan for the next time the market tanks.
Hanging On to an Investment For Too Long
Just like a boxer needs to learn how to take a punch, investors must eventually learn to take a loss. Not every investment will be a winner. It takes emotional discipline to recognize the mistake and cut your losses.
“If it just stinks and is never coming back, don’t hold onto it for 10 years trying to make your money back, because you may never get it,” says Panaccione.
How to recover: Instead of hanging onto a dead investment, take the tax write-off provided by a capital loss when it makes sense for your overall tax picture. Bankrate’s story, “Use capital losses to cut taxes,” explains the tax considerations of deciding when to sell a security.
“If people are taking a risk on an investment, they may as well do it in a taxable account where they can take advantage of the tax write-off. If it goes screaming up you might get taxed on it, but I don’t think you’ll mind if you make a ton of money. On the downside, you don’t want to have it tank and miss the write-off because it’s in an IRA,” Panaccione says.
Falling Into a Black Hole of Credit Card Debt
Buying on credit means you are agreeing to spend your future money on today’s impulse buy. Often it’s a decision your future self-will regret, and it propagates a cycle of debt.
“People keep making choices today that make it so that their current income to the household keeps paying for past choices,” says Julie Murphy Casserly, Certified Financial Planner and founder of JMC Wealth Management in Chicago.
How to recover: Discontinuing all purchases and living off rice and beans until the credit card debt has been paid seems like a solution, but it rarely works.
“If they take all their money today and don’t live in the present moment and don’t plan for the future, then they’re only going to keep recreating that financial past over and over again,” Casserly says.
Instead, she recommends finding a balance among paying off the past, enjoying your present and saving for the future.
“If you deny yourself something you want today, in the future you’re going to act out and jack up your credit cards again. I’ve watched it again and again,” she says.
You can still splurge, but save up first. It will be much less costly in the long run.
Taking a 401(k) Loan
There are some good reasons to take a loan from your 401(k) — for instance, when you have absolutely no other options and the repo men are on their way to your house.
”Other reasons may just be elaborate rationalizations,” says Casserly.
“People justify to themselves why they’re taking the loan by saying, ‘I’m paying myself back.’ You’re not making back all the interest. There are administrative costs and fees that come out of the interest,” she says.
How to recover: Recovering from a 401(k) loan takes time. Pay back your loan and save for the next big purchase or fund an emergency savings account rather than falling back on money that should be untouchable.
“Savings accounts are too accessible for the average American today. My suggestion and solution is create an account that is not accessible at your local bank or ATM and then save systematically on a monthly basis,” Casserly says.
“Very few people have three to six months’ of living expenses in a savings account because they say, ‘Oh, but I had to go on vacation,'” she says.
Save up for a rainy day to avoid raiding your retirement account.
Trusting Those With Limited Expertise
It can be tough to sift the good investment advice from the bad. Because of that, consumers are often at the mercy of professionals — or victims of their own greed.
“I don’t care if it’s cousin Billy Bob or a well-intentioned insurance agent, they’re giving you advice on products or subject matter that they are either not licensed for or they don’t understand,” says Chris Ravsten, Certified Financial Planner, principal and founder of Foxstone Financial Group in Denver.
How to recover: Sometimes moving on is the best way to recover. That, and accepting the situation as a painful learning experience, though it’s hoped not a terribly expensive one.
But for the future, be aware of who is giving you investment advice, what they are licensed to sell, what products their firm sells and how they get paid.
“The simple litmus test is to make sure their firm has a full range of products and services and they are licensed to sell a full range of services and products. Not just one product,” says Ravsten.
The Securities and Exchange Commission offers some recommendations for investigating brokers and investment advisers.