Up until this point, many of us have made plenty of mistakes and that includes financial mistakes, for example, we make countless decisions about earning, saving, and investing.
If we work for 30 years and retire for 20 years, then we would make money-related decisions for over 50 years.
If you’ve studied probability, then you will know that the chance of us making the right decision 100% of the time is mathematically very improbable. We are all prone to blunder now and again.
When we make a mistake, we have two options. We either learn from it or we don’t. In the latter case, we might make the same mistake again in the future without really knowing why. Maybe you cannot stop yourself from participating in IPOs or betting on penny stocks.
There may be times when you turn a profit and you brag about it. On the flip side, there may also be times when you make a loss and you try to forget about it.
No matter what the case may be, any new opportunity that comes up will be tempting.
Financial Mistakes and Information
Why do mistakes happen in the first place, though? Clearly, there is nothing wrong with our brains. In most cases, that is true. You see, the problem isn’t with our brain. They process information normally. When it comes to making decisions, our brain usually looks at two things: past experience and information.
The first element is straightforward. We simply look at the outcome of similar situations in the past and use that to guide our decisions. Based on past events, we may create some rules for yourself such as: “Never attempt to pet a wasp,” for example.
Using these rules, we optimize our brain’s usage by automating some of the rule-based tasks so we can act without conscious effort. So with enough experience, you should have created a system of rules that would help you make the right decisions.
This brings us to the second element – information.
There are a few things to know about information:
- There is no such thing as complete information outside case studies because it would take forever to get complete information on anything.
- The decisions you make are as good as the information you have at hand
- Past experience can influence how you process information
Simply put, there will always be noise with the information we feed the brain and the decision-making process. Sometimes, we fail to gather enough information and make the wrong decision.
Sometimes, we think we have all the information at hand, but we were fed bad information so that backfired. In some other cases, we have the best information we could have, but personal biases (from past experience) change how we interpret the data we have and cause us to make poor decisions.
This is a problem because, more often than not, personal finance decisions involve many choices that lead to just as numerous results.
It is difficult to tell apart the good information from the bad and we tend to have a very messy process when we make a decision.
The outcomes, no matter good or bad, will leave an impression within us. We walk away from the decision with some experience, but it may not be specific enough to be applied in the future.
In reality, every situation is unique, so there is no one-size-fits-all solution, especially in personal finance. This is why most advice you get from others is often general rules even if they sound too general to be actionable in your particular situation.
Let’s take a look at some common financial advice you will hear:
- Save before you spend: Put money aside into your savings account first before you start spending, just to make sure you don’t overspend and end up cutting into your savings.
- Spend within means: Simply put, never spend more than you earn.
- Don’t borrow: Due to interests, you’ll end up paying a lot more than if you were to pay for everything upfront. Unless you can get more value out of something than its value and interests, don’t take loans.
- Insure first, invest later: Protect yourself and your assets first before you extend your resources into other investments.
- Invest your savings in a diversified portfolio: If one investment fails, you have others to soften the blow. Never put all your eggs into one basket.
- Allocate assets based on needs: Invest your savings in each asset based on expected rates of return, higher ROI (return on investment), higher investment.
- Set specific goals: Be clear with where you want to be in the future so you have a sense of direction. Goals should be realistic, measurable, and time-bound (with deadlines).
- Save for retirement: The ultimate goal in personal finance. Make sure you have enough money to retire comfortably.
As you can see, these are vague at best. Everyone cannot apply this advice uniformly because of their unique circumstances.
Think of these rules as general directions rather than a specific that you can incorporate into your life. Other than that, these rules have their trade-offs and decisions that can either result in rewards or regret.
Take the first advice “Save before you spend”, for example. How much savings is enough? There’s no real answer to that. Many people are either overindulged and do not put enough in their savings account, or being too frugal and end up denying themselves the joys of spending.
After all, money is meant to be spent one way or another. It’s just as valuable as a piece of paper if you don’t spend it.
Let’s take a look at another piece of advice, “Don’t borrow”. The general idea is that we end up paying more in the end if we take a loan rather than paying for the full price upfront. This also differs in various scenarios.
Many people take out a home mortgage loan, upgrade their cars, or overuse their credit cards. The idea of loans is that you can spend tomorrow’s money today and this is not necessarily a bad idea.
As you consider all the rules and advice you’ve heard from others, you will find that there is information supporting all decisions. You have enough reasons for and against putting the advice into practice.
You can find such information when you talk to your family and friends, or hear from the press and media, etc.
There is always too much information but that does not mean you will have enough good information. Many personal finance decisions are made when a person is suffering from information overload. This will often lead to analysis paralysis and no decisions are made or making a wrong decision, realizing it is a mistake, then do it all again.
So, in light of all this, what should you do? What should you aim for? There are a few things you can do to minimize making bad financial decisions.
Minimizing Risks and Learning From Mistakes
First, never make the choice of personal finance inertia. This means deciding not to do anything, which often results from analysis paralysis.
This is a condition in which you want to analyze all the information before you make a decision. In this case, since there is too much information, you end up not making any decision because you cannot analyze all the information.
Worry is also partly to be blamed here. We worry that we will lose something if we act and in inaction, we can retain what we have. In reality, we stand to lose more than we gain when we compare the value of money to lessons or experience in personal finance.
It is often better to make mistakes than to do nothing at all because you at least get to learn something.
Second, when you make a mistake, find the lesson. Making financial mistakes is only worthwhile when it is a new mistake and you learn something from it. Otherwise, you might as well not do anything.
Third, remember that there are always personal limitations that will hold you back, causing you to make wrong decisions. This is something that is just there and there may not be much you can do about it.
Maybe you are unwilling to control how much you spend; perhaps you are too attached to possessions or property, or you might associate trading with gambling, so it is hard to give it up.
You might need to see mistakes differently. Instead of seeing it as a shameful blunder, think of it as a learning opportunity. Every mistake you make allows you to look at the situation and understand what you should have done.
At the very least, you know how flawed your decisions were. You might discover some personal biases you did not realize were there before and can do something about it.
Fourth, remember that there is always the possibility for correction, especially when it comes to personal finance. Other than some few fortunate inheritors, many of us earn, save, and spend money over a long period of time. Because of this, it should be possible, even easy, for us to correct certain financial mistakes.
There is always an opportunity to fix an ill-placed fixed deposit, a wrongly selected IPO, a wrong mutual fund, or a faulty insurance product.
There should always be an exit for you in these sorts of things; you just have to know when to get out before things get worse.
Never put all your eggs into one basket.
Your life’s earnings, savings, or investments should be distributed into various areas so if you make a mistake, the profit you make from other investments can absorb the shock and the mistake won’t be too expensive to correct.
Finally, remember that the best thing about rules is flexibility. If you want, you can create a system consisting of only a few rules that can become your personal financial habits.
You might even have a conservative default position that can act as a safety net to compensate for other mistakes you might make with the money in the future.
Never let a mistake go wasted. It is a mistake to let a mistake go wasted. It gives you new insights and helps you change your personal financial life accordingly.
Other than that, what other things can you do?
How to Recover From Financial Mistakes
Of course, no matter how much you prepare and gather information, they will only get you so far. You can and will make mistakes now and again.
The last thing you want to do when you’re knocked down is staying down.
You want to pick up the pieces and move on as soon as possible. In personal finance, you might not be able to recoup all the losses, but there are a few things you can do to minimize the damage.
First off, stay calm. It’s easier said than done but do your best. When you’re hit with a setback or when you realize that you’ve made a mistake, you will feel as if you’ve been punched in the stomach. It’s very easy to feel overwhelmed.
If you feel like you want to spring into action, then your zealousness is commendable, but the last thing you want to do right now is to act without fully understanding the situation. Just relax, take a few hours to distract yourself, or sleep on the problem.
Give yourself some time to get a better perspective on the situation.
Certain mistakes can be reversed to a certain degree, so do that if you can to recoup your losses. If you just blew a load of cash on an Xbox or some new clothes and realize that it’s a big mistake, see if you can return them. If not, consider selling them to someone else and at least get some money back.
If you sign up for a gym membership that you now regret, maybe you can still cancel the contract during the grace period. In short, see if you can undo your mistake.
Evaluate your options
If you cannot reverse the mistake, make the best of your situation. What can you do in the situation? You want to look at your long-term goals and act accordingly, not make a decision in the spur of the moment.
Don’t let it get you down
When you make a mistake, you might be tempted to spend more money to ease the pain. I understand that it’s probably a painful blow, but the last thing you do is make another mistake. Many people buy stuff just to feel better, some call this retail or shopping therapy but it will have the opposite effect. You may feel guilty after making the purchase, which makes you want to cope by buying more stuff, which makes you feel more guilty… You see how this can turn into a vicious cycle.
So, fight that temptation. Never let one problem snowball into several more.
Learn from your mistakes
I’ve said this once, and I’ll say this again. Learn from your mistake. It’s a mistake not to learn from your own mistakes because you’re doomed to repeat them.
Don’t fall into sunk-cost fallacy
Simply put, it is the belief that one should continue to invest more and more into something instead of cutting their losses and back out simply because they’ve invested so much into it already. You feel that you’ve already committed to this and you might as well go in all the way and hope things work out in the end. This can be very dangerous.
Learn to recognize when you should cut your losses and bail.
In short, no matter how hard you try, you will make mistakes. If you want to avoid making financial mistakes, you just have to not dabble in personal finance at all, which is an impossible task. The best you can do is minimize the risks and do your best in deciding on a course of action. If you fail (and you will), learn from your mistakes. Every mistake you make will make you a wiser person. Eventually, you can put your knowledge to good use and become successful.