What an incredible gift to learn from others’ mistakes. It is a blessing to not actually make the mistake and still incorporate that knowledge and experience into your own life.
Imagine if you had to make a mistake to learn anything. Life would be tough. Life would be really tough.
Thankfully, people come before us, make mistakes, and often pass on the lessons from those mistakes.
Before we explore financial mistakes, let me tell you a short story about a hiking mistake I made about a decade ago and how it relates to your finances.
Living in the Pacific Northwest, we have beautiful hiking year round. In the summer, we see wildflowers, alpine lakes, and gorgeous mountain views with lively wildlife. In the winter, many trails remain accessible if you have snowshoes or microspikes.
Two friends and I decided to make a weekend trip up to Hurricane Ridge, which is at an elevation of 5,242 feet. It’s known for unpredictable weather, intense winds, and snow – lots of snow. It receives about 400 inches of snowfall each year.
As we set out on one of the snowshoe trails, we had great visibility. It was a beautiful day and the trail was well marked. We had talked with the ranger ahead of time to learn more about the avalanche conditions and what precautions we should take. As we left the ridgeline to push to a higher elevation, conditions were worsening. Visibility was still okay, but looking back on it, we should have turned back.
After snowshoeing for some time, the conditions were terrible. We decided to turn back. The problem was we could hardly see 10 feet in front of us. The only marker we remembered was a sign post, barely sticking its head above the snowpack. We couldn’t see the ridgeline we had come out of.
I spoke with one of my friends to see if he had any idea which direction we should be heading. He didn’t either.
At that point, I was concerned. It was late in the day, and the sun would be setting soon. The visibility was still awful, and while we had a general sense of which direction to head, neither of us were confident, and my other friend had little experience hiking.
We decided to head back up the mountain because we thought we had passed the sign post, but had been off course. We backtracked and headed down again because we thought it was more to our left.
Thankfully, we made it down to the sign post, but we could now see two ridgelines. Which did we come out of?
We debated it for a moment, and my friend chose correctly.
We made it back to the ridgeline and back to our car safely.
As I look back on it, we made plenty of mistakes – mistakes that should have been prevented. We should have stopped at the ridgeline and turned back. We should have carried a compass or GPS navigation with us. We should have started earlier in the day. We should have carried more gear for winter conditions.
That day could have turned out much differently for us.
I carry those mistakes with me every time I go hiking now, particularly in winter conditions. I returned to Hurricane Ridge about two years ago, wiser, and turned back on a different trail when conditions worsened and the trail became difficult to track.
What does this have to do with finances?
You don’t need to experience a mistake to acquire knowledge about. You can learn from others and internalize their experiences to make smarter financial decisions.
I should have done that when hiking. I could have taken a winter safety course. I could have heeded the advice of every online article talking about carrying the 10 essentials. I could have learned in other ways than actually making the mistake.
I’ve previously written about common money mistakes. Let’s explore financial mistakes people make that can lead to catastrophe and what you can do to prevent it in your own life. These are in no particular order.
Mistake #1 – Too Much Leverage
As Warren Buffett once said, “Never risk what you have and need for what you don’t have and don’t need.”
There seem to be more people taking on debt to invest, as evidenced by a recent study by MagnifyMoney.
They found 80% of Gen Z have taken on debt to invest.
Debt itself is not concerning, but debt to invest and without properly understanding what it can do to your portfolio is concerning.
For example, let’s say you have $100 and buy a stock worth $50 a share. You also decide to take on $50 of debt, which allows you to buy another share. You own three shares of the stock worth $150 and a $50 debt, which means your net amount is $100.
What happens if the stock doubles and goes up to $100? Now, your three shares are worth $300 with a $50 debt. Your net amount is $250.
Although the stock went up 100%, your return is 150%. (Calculation: ([$250/$100]-1)*100).
That’s leverage. And, it works in reverse.
Instead of the stock going up 100%, let’s assume it goes down 50%. Now, each of your shares went from $50 a share to $25 a share. Given that you have three shares, your shares are worth $75 total and you still owe the $50 debt. Your net amount is $25.
What’s your return? -75%. (Calculation: ([$25/$100]-1)*100).
The problem is that depending on the lender, they may not allow the shares to fall that far without selling your shares or requiring you to deposit more money.
If you borrowed the $50 on margin, that means you used your investments as collateral (much like your home is collateral for your mortgage), but you also are susceptible to a margin call, which is when the custodian who allowed you to borrow the money demands that you deposit additional cash into your account or they will sell your shares to pay off your debt.
Let’s take it a step further and say the shares drop in price as soon as the market opens to $10 a share because of an accounting fraud. Now your shares are worth $30 and you owe $50, meaning the net amount that you owe is an additional $20 after your shares are sold to cover your $50 debt. This isn’t exactly how it works in the real world, but you get the point.
Leverage amplifies returns, both positive and negative.
Personally, I don’t see the appeal of using debt or margin to invest in the stock market. There are some cases where it makes sense for short-term borrowing needs, but the risk must be managed effectively.
Learn from others to avoid the mistake of too much leverage.
Mistake #2 – Not Making Minor Adjustments
There is a 1 in 60 rule in air navigation that says for every one degree a plane is off course, it will miss the final destination by about one mile for every 60 miles flown.
Although one degree sounds small, over many miles, it can make a material impact. For short trips, there is little impact. If you are traveling 480 miles and are off one degree, you’ll be off by about 8 miles. Not great, but not terrible. It’s likely easy to fix at the end.
However, if you go 30,000 miles, you would be off your final destination by about 500 miles. That’s more difficult to correct at the end.
Let’s use this same concept for life. If your timeframe is a day, getting off course by one degree for a day is not life altering. You may spend a little more than you intended on lunch or decide to splurge on an afternoon iced drink. It does not wreck your finances.
However, if you are in your 30s and assume a normal life expectancy of 50 plus more years, one degree off course can mean the difference between a fulfilling life and one with severe regrets.
It only takes a small adjustment, one degree, to impact life many decades down the road. It could be saving an additional $50 per month, investing a few hours a month in continuing education, or exercising for 20 minutes in the morning.
It sounds small, but a small course correction compounds in the right direction.
If you start saving an additional $50 per month for 30 years and earn 7% per year, you will have a little more than $56,000 at the end of the 30 years.
What happens if you don’t course correct as soon and start saving 15 years from now?
You’re left with only about $15,000.
Minor adjustments don’t look like they do anything in the short-term because most of their impact is felt 10, 20, or 30 plus years from now. That’s what makes them difficult to do. There is little reward today.
The beautiful aspect of minor adjustments is they often are hardly felt today in comparison to the major adjustment needed later. In the prior example, the major adjustment would be needing to come up with an additional $41,000 because you started saving late.
Learn from others’ mistakes by making small changes now. You may not feel it, and that’s okay. That is the point.
If you are overspending, cut it back by $10. If you want to save more money for retirement, start with $10 more per month. If there is a change you want to make in your financial life, make an adjustment, no matter how small it feels.
Mistake #3 – Buying Too Expensive of a House
Have you heard the phrase house rich and cash poor?
There is a reason it continues to be said. People frequently buy too expensive of a house, stretching their budget to the point where they can make payments, but they are one emergency away from experiencing serious issues.
As a general rule, banks are willing to lend an amount that would make your mortgage payment 28% or less of your gross income. If you make $100,000 per year, that means they would lend to a point where your monthly payment is about $2,333.
Should you borrow at 28% of your gross income?
It depends. In a higher cost of living area, it may be unavoidable. There are plenty of people who go to the top of that range when it’s not needed. They could buy a $400,000 house, but decide to buy a $600,000 house instead. It might be a different person who could buy a $700,000 house, but stretches for a $1,000,000 house.
It does not matter the final price because each person’s finances are their own. What matters is how that price is relative to their income and lifestyle. If someone spends the majority of their paycheck on the mortgage payment plus an average of 1-3% on home maintenance each year, that may not allow them to live in the way they want.
They may need to forego travel, saving for retirement, or gifting to people or charities.
We have been in a very good market cycle for housing recently, and there is no telling when it will stop, but it likely will one day.
We are more than 10 years away from the financial crisis, but as of a couple years ago, there were still people underwater on their homes, where their mortgage is worth more than their home.
A slow down in the economy can lead to job losses. If you require a high income to afford your home and you lose your job, you may be forced to sell. Unfortunately, when you need to sell may be when many others need to sell, which could drive home prices down. There were many situations where people had their homes foreclosed on, sold in a short sale, or walked away after a bankruptcy during the Financial Crisis.
I don’t think of a home as an investment. It’s a place to live. The value will likely increase over time, and you may use the equity one day to downsize, but I don’t count on it personally.
Learn from others by finding a home that fits your lifestyle. Plenty of people have made the mistake of buying their dream home, only to find out their dream home consumes too much of their income and puts them at risk in difficult economic times.
Summary – Final Thoughts
Learning from others is a gift. Listen to people of all ages, all walks of life, and add to your knowledge. Most people love to talk about themselves, usually about wins, but sometimes you’ll hear about mistakes.
Assemble the collective wisdom of others and incorporate it into your own life. You may be surprised what you walk away with.
As I’ve talked with people about money, mistakes that can lead to catastrophic consequences are borrowing too much money, not making minor adjustments, and buying too expensive of a house.
If you can avoid those mistakes, you will likely be happier with your life.
What mistakes have you made or seen others make? I’d love for you to share.
Lastly, I started writing weekly financial blog posts one year ago. This is a big milestone. If you enjoy the posts, please share with a friend!