Big Mistakes

Michael Batnick of Ritholtz Wealth Management recently authored an excellent book, Big Mistakes: The Best Investors and Their Worst Investments, detailing how many well-known, successful people—including Warren Buffet, Mark Twain, and Jack Bogle—have failed at some point in their investing lives. The takeaway? Everyone makes mistakes; what’s important is learning from them. I particularly enjoyed the final chapter, “Looking in the Mirror,” in which Michael shares mistakes he’s made both in investing and in life. A growing body of research suggests vulnerability is important to establishing connections, and Michael certainly demonstrates this in his book.

Taking a cue from him, I have decided to share my biggest personal finance mistakes, each of which have been instrumental in shaping my investment philosophy. As it happens, I uncovered these blunders during the Great Financial Crisis. Just as a rising tide lifts all boats, you don’t really learn whether successes are attributable to good fortune or skill until the spaghetti hits the fan—and, oh boy, did it get messy following the collapse of Lehman Brothers in September 2008. In the spirit of viewing mistakes as learning opportunities—and in hopes it may save others from similar travails—here are my biggest personal finance mistakes:

1. I didn’t establish a cash cushion as a safety net. I viewed my investment portfolio as an extension of my savings and failed to put aside three to six months’ worth of expenses in cash. Granted, I was just a year out of business school and hadn’t had much time to save. Nevertheless, ensuring I had adequate liquid assets to tap in an emergency should have been a top priority.
2. I overconcentrated my portfolio. As the famous investment adage goes: you get rich through concentration and stay rich through diversification. Unfortunately, I did not consider the alternate scenario: you can get poor through concentration, too! If you want to go the concentration route, you either need to control your destiny (i.e., a business owner or executive able to steer the ship) or know your positions intimately to determine an appropriate time to exit. At the end of 2007, my individual portfolio included fewer than ten names, with the top three accounting for 70%. More than 55% fell within the financial sector, and I had no exposure to bonds or other diversifying asset classes.
3. I failed to set a goal for my investments. I viewed my taxable portfolio as assets earmarked for growth, but I never identified a true goal for them. Though I knew my portfolio was of sufficient size to serve as a down payment on my first home or funding if I ever wanted to start a business, I never considered when those events might occur. As a result, I didn’t reduce my stock risk as those potential events drew closer.
4. I let the fear of taxes drive my investment approach. Yes, it is important to be cognizant of taxes—I come from a family of CPAs, after all. However, choosing not to rebalance in order to avoid realizing gains was not my best decision. I compounded this mistake by not realizing some gains in order to make a down payment on my first house. Thankfully, this was 2007 when underwriting standards were sufficiently loose (more on that in a bit).
5. I was too greedy with my first mortgage loan. I can’t fault my mortgage broker for encouraging me to take the 0% down loan. He got a larger commission, and I was well aware of his potential conflicts of interest. My wife and I both had full-time jobs, and the 6% fixed-rate loan (remember, 6% was considered a great deal in 2007!) payment was well within our budget.

Fast forward to the summer of 2008: Bear Stearns had been taken over in March, and—unbeknownst to anyone at the time—larger collapses, including those of Lehman Brothers and Wachovia, were just a few months away. The Great Financial Crisis unfolded for me as follows:

• Wachovia crashed. Roughly 20% of my pre-crisis portfolio was in Wachovia stock. I could have easily used this position to put down 20% on my first home purchase, but I didn’t want to pay any capital gains tax. Wachovia stock went from $38 at the end of 2007 to $3.50 just nine months later, delivering a crushing blow to one of the largest components of my portfolio.
• The job market dried up. I left my stable, yet unfulfilling job to find something more analytical after passing Level 3 of the CFA exam. I had several promising leads to manage investment portfolios at a number of endowments and foundations, along with a part-time opportunity helping to establish a renewable energy financing firm. When the financial crisis hit, budgets froze, open positions vanished, and leaders turned their full attention to steering their organizations through the turmoil. I sure could have used a cash safety net during this period of uncertainty to soften my anxiety about finding a new job.
• Mortgage rates quickly dropped below 5% and continued to fall. My wife and I were down to one commission-based income that was tied to the financial markets. While our monthly mortgage payment was manageable on just one income, lower mortgage rates meant the potential for a substantial reduction in our monthly payment. Unfortunately for us, bank underwriting standards had tightened (wisely for the health of the banking industry), eliminating 100% mortgages. Since I had not established a cash cushion, nor had I reduced my exposure to the stock market, I had to sell some of my positions at much lower valuations in order to make my down payment to take advantage of a lower mortgage rate. That one really hurt!

My experience living through this roller coaster helped me refine a number of important philosophies for my personal finance:

• Put first things first. Build a safety net of cash to cover life’s “oh no!” moments before taking on more risk for growth.
• Develop a portfolio to accomplish one’s goals. Once you have a comfortable safety net, consider your portfolio and how you want to use it. For example, maybe you want to save for a down payment on a house in five years or cover the costs of your child’s future educational expenses. The investment allocation should be consistent with your goals and timeline for when they should be met.
• Focus on diversification and cost control. Successfully picking stocks is extremely hard to do, even with my Chartered Financial Analyst designation. I now find it much more effective to gain the exposure I need through ETFs and index funds. This allows me to spend more time ensuring I’m in the appropriate allocation for my goals and risk tolerance.

It hurts when a number of mistakes compound upon one another, but I was fortunate to have made them relatively early in my career, allowing plenty of time to learn and recover from them. While I am sure I’ll continue to make mistakes—no one is perfect, just read Michael Batnick’s book—I’m hopeful my philosophies for personal finance will mitigate any negative impacts, thereby allowing me to meet my long-term financial goals.