I was sitting down to write tonight when I noticed a calling from A Journey to FI to document our personal financial mistakes with the intent to help others avoid the pitfalls of personal finance. I made plenty of mistakes over the years, too many for a 1,000 word post. For the purposes of this post, I picked the big ones. The ones that took years to fix or realize the mistake. The lessons below continue to make a huge impact on our financial well-being.
My favorite quote on making mistakes:
If you want to increase your success rate, double your failure rate – Thomas J. Watson
This quote is all about pushing boundaries and learning from mistakes. Anyone who is recognized for their skill, got there by learning from their mistakes. Even Warren Buffett routinely acknowledges his investing mistakes in public. He will go down in history as the greatest investor ever.
Come to think of it, here is an even better quote from Warren Buffett:
It’s good to learn from your mistakes. It’s even better to learn from other people’s mistakes.
With personal finance and investing, I think Warren Buffett’s quote trumps all others. Its better to learn on someone else dime.
My Biggest Financial Mistakes
1 – Purchased a new car at a price of half of my annual salary
After college, I started a new job making $42,000 as a junior software engineer. Within the first month on the job, the car I had driven for years rolled over 200,000 miles and needed a very costly repair. Instead of making the repair, I purchased a brand new car. It was a two door Chrysler Sebring with a price tag somewhere near $20,000. To add to the insult, I financed this purchase over five years paying 6% interest.
I lived in the city and drove about five miles to work. The rest of the time, I would walk everywhere. There was absolutely no reason why I needed a new car. None. I only drove to work and barely used the car other than to visit extended family.
- When you are broke, you should avoid all purchases where you have to pay interest. (Unless it is a student loan or mortgage.)
- Never finance a consumer purchase.
- Do not spend more that 10% of your annual income on a car.
2 – Purchased a home with a second mortgage
2006 was a big year for me. I got married, finished my MBA and started working my dream consulting job. Soon after, my wife and I purchased a house without saving up for a reasonable down payment. Sometimes I wish I could travel back in time and slap myself.
We purchased a townhouse with 5% down in 2006. This was at the peak of the market in our area. I can remember the exact conversation with my wife discussing whether we should buy while we were waiting for our food at the local microbrewery.
The housing market was exploding and we thought we would miss out on being able to afford a three bedroom two bath house. The time to act was now, or so I thought. In hindsight this was a horrible decision for three reasons
First of all, it was just the two of us. We had no need for a three bedroom house because we knew we were waiting to start a family until we were more established in our careers. There was no rush other than a desperate fear of missing out.
Second, when you purchase a house with a second mortgage you end up writing multiple checks. In addition, your payment also includes primary mortgage insurance. PMI, is an extra insurance for making the risky loan. This was costing us an additional 1% of the purchase price every year until we could prove our equity portion was worth 20%.
Third, the market collapsed. The value of our house deteriorated. In 2006 we purchased it for $275,000. In 2009 we relocated to Georgia and the home sold for $240,000. Luckily, we were bailed out by my wife’s company. As part of their relocation assistance they purchased the home for the original purchase price plus any capital improvements we could prove. Once they took ownership they immediately dropped the price and sold it at a loss.
- Always buy a home with at least 20% down.
- Fear of missing out should never be a factor when buying a home. There are plenty of homes out there.
- Never rely on getting lucky. Home ownership is a long-term commitment. Only buy when you are certain you will stay for at least ten years.
- Interest rates matter. Refinancing when you have a second mortgage complicates the situation.
3 – Saved only the minimum in tax deferred accounts
Deferring taxes, especially when qualifying for higher tax brackets is a blessing. For the first few years, we only saved enough to get the employer match. For us, that was about 6% of our income. We could afford to contribute more early on and our accounts would likely be significantly higher. Why didn’t we max out our accounts early on?
The opportunity cost was too great. We had a home to furnish, financed automobiles and loved expensive vacations. We ate out, every weekend. Not just pub food, we were turning into regular foodies. All of these things outweighed our desire to stuff our retirement accounts.
- The opportunity cost of not funding a retirement account will jeopardize your future self and plans for early retirement.
- Compound interest is wonderful. Tax free compounding is even better at accelerating your net worth.
4 – Overly conservative with investments
In our 20’s, we chose a portfolio allocation with more than 50% bonds even though we had an investing lifetime of returns to make up for any downturns. We couldn’t stand to lose our
hard earned money principal in the market. This was far too conservative. Our investments might have kept pace with inflation, but we weren’t increasing our purchasing power over time.
We didn’t understand how risky this allocation was. Ultimately we got lucky due to the great recession and a super conservative portfolio. Our losses were minimal and learned to allocate a bigger percentage to stocks at the right time when the market was low. This wasn’t timing the market, this was dumb luck.
- By over allocating in bonds we were risking the chance of getting rich by minimizing volatility. We learned to allocate an appropriate amount to bonds for our age and goals.
- Quality stocks give the best return over time. After I read “Stocks for the Long Run”, I understood that stocks, when held for 10 years or more were actually less risky.