Yes, even the most successful people are prone to falling flat on their faces, financially speaking. But we can all learn from their expensive blunders.
It’s easy to assume that there are two kinds of people in the world of money: those who are ‘in the know’, and the rest of us. After all, the privileged few must surely be adept in the art of money management – a skill which most people never learn.
Having lived at both ends of the economic spectrum (and various points in between), I can tell you it’s simply not so. Educated, experienced people – including those with the biggest bank accounts – make mistakes with money, too. From informal conversations I’ve had over the years on the beaches of St Tropez, in cosy restaurants in Mayfair, and palatial Fifth Avenue apartments, here are some of the blunders which I’ve frequently heard smart people making. People like you, perhaps?
Letting tax consequences shade their judgment.
Having watched the value of an investment rise to produce a substantial gain while sceptical that the price rise will continue, you decide not to sell because you don’t want to pay the tax on the realised gains. Since March 2000, when the market began its decline, even the genetically tax-phobic have learned that paying taxes on realised gains is a lot more satisfying – and lucrative – than sitting on losses that you may not recoup for years.
Concentrating too much on one class of assets.
When people make profits in one type of investment, such as property, stocks or unit trusts, they tend to put an increasing amount of money into that asset group. Thus they magnify their exposure to a price decline in that sector while ignoring diversification and periodic asset reallocations, two cornerstones in prudent financial management.
Using a volatile asset as collateral for a loan.
In the heady days of the late 1990s, a person who had huge unrealised gains in his or her technology and Internet shares sometimes decided to use them as collateral for a loan. This borrowing against the appreciated value of stock is called leveraging or margining an asset. The individual might use the borrowed money to build an extension, take a luxury holiday, buy a car or purchase more shares in the same company or sector. When the shares’ value suddenly plummeted below the amount of the loan, the lending firm would ask the borrower either to pay back part of the loan or deposit more assets immediately. Instead of borrowing, a more prudent decision would have been to sell part or all of the shares (realising the profits) and then use only part of the profits to buy your next investment.
Changing strategies in the middle of the game.
Market trends can lead even smart people to abandon a time-tested, prudent, rational strategy. In the late 1990s with stock prices doubling every two or three years, many people became euphoric and a little too optimistic. Instead of selling enough of their holdings to get back their initial investment and then let their profits continue to make money for them, they left every penny on the table. Result? When the sharp decline hit, years, worth of gains were wiped out. This lesson here is to stick with a strategy that is true to your risk tolerance long-term investment strategy and market experience. As with the approach of Warren E Buffett, highly successful CEO of Berkshire Hathaway Inc, your strategy may not produce the biggest gains in a given bull market, but it may also not lose the most when the market inevitably turns bearish.
Not having enough cash or liquid assets.
When you see the money you’ve invested in certain assets (for example, property or shares) grow by significant amounts per year, you can quickly convince yourself that leaving some cash in a savings or building society account is wasteful. It is not. Having a sufficient cash cushion helps you avoid having to conduct a ‘fire sale’ to raise cash if something unexpected arises, such as sudden unemployment or a family emergency.
Thinking you (or someone else) can outsmart the market.
Don’t let a profitable period in the markets go to your head or cause you to believe in someone else’s infallibility. No one can consistently foretell what will happen in any investment market, whether it’s shares or property. It is best to remain a student of the markets rather than strive to be a conqueror of them. As I once overheard once a long-time professional money manager say: ‘These markets will always teach you new lessons, whether you like it or not.’
Trading on rumour.
A tip whispered during a golf game or at a lunch in the City by a friend Owith connections’ is often thought to be a guarantee of profits. People conveniently forget that rumours and gossip are not facts! And, perhaps most importantly, you don’t know how far down the rumour chain you are. You may be the hundredth or thousandth person to hear the hot tip, in which case the markets will have already absorbed the impact of the news, making further profits almost impossible. If followed, these ‘sure bets’ will often cause you to lose more than just your trust.