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WHEN I SET OUT TO improve my financial knowledge, sites like HumbleDollar didn’t exist. Instead, I garnered insights from books, investment seminars and like-minded people. Still, my greatest lessons came from my own financial mistakes.
I’ve made many, and I still occasionally stumble. A few missteps were costly and had lasting repercussions, but the rest were less damaging, especially considering the lessons I learned from them. Here are six of what I call my “affordable mistakes.”
1. Investing in individual stocks without research. After losing years of investment compounding by ignoring the stock market, I foolishly adopted an invest-now-research-later approach. Relying solely on company name and price history, I narrowed my buy list to a dozen or so public companies and then invested equal amounts in each.
Among my selections were two familiar names. I knew about Eastman Kodak from my college days, when one of my hobbies was developing film. And I was familiar with Washington Mutual because the bank sponsored a spectacular annual firework display that I loved to watch. I naively assumed that these stocks, together with the others I chose, would be good long-term investments. They weren’t.
Both Kodak and WaMu eventually failed, leaving me with no chance of recouping my investment. I figured that unless you enjoyed stock research (which I didn’t), had a strong desire to beat the market (which I didn’t), and could dedicate time to staying on top of company and industry news (which I couldn’t), it made no sense to favor individual stocks over low-cost, diversified stock funds.
2. Borrowing from my 401(k). In my mid-30s, when I was going through a financially challenging period, I found myself in need of immediate cash. My 401(k) plan offered a loan that seemed appealing. The paperwork was minimal, the funds would be available within days and the interest I paid on the loan would go into my 401(k). Faced with a time crunch, I applied for the loan and used the money as soon as it was available.
But within a few months, I realized my mistake. No, the problem wasn’t my ability to repay the loan or hold onto my job. Rather, the stock market was in a slump when I took out the loan and started recovering in the months that followed. The opportunity cost of selling at a low point and missing the subsequent market rebound was significant. To minimize the damage, I repaid the loan sooner than originally planned.
3. Constructing an unwieldy portfolio. As I learned more about diversification, I decided to rebuild my portfolio. I allocated a portion of my money to broad market index funds, while using the remainder to add variety. But I lacked a clear understanding of which varieties to add and in what proportions. I began investing in anything that seemed unique or interesting, resulting in an excessive number of holdings with no discernible purpose. It was akin to using every spice in the kitchen to cook a single dish.
The various specialized funds I bought included those focused on micro-cap shares, equal weighting stocks, business development companies, master limited partnerships, commodities, mortgage real estate investment trusts, high-yield stocks, dividend-growth shares, frontier market stocks, convertible bonds, mortgage-backed securities and more. If I’d continued this approach, I might have ventured into non-fungible tokens, special purpose acquisition companies, cryptocurrencies and meme stocks, too.
Soon enough, my brokerage account became unmanageable and, quite frankly, absurd. Luckily, I realized my mistake before my holdings had notched significant capital gains. I was able to sell and declutter my account without too big a tax cost.
4. Paying the ignorance tax. After paying off my mortgage and reducing other fixed living costs, it dawned on me that my annual tax burden was larger than all my other expenses combined. How did that happen? Not only was I failing to make full use of tax-sheltered retirement accounts, but also I was keeping the wrong investments in my taxable account.
To rectify the problem, I took three steps. First, I began making after-tax contributions to my 401(k) and then converted them to a Roth 401(k), where I invested the money in a growth stock fund. Second, I shifted most of my bond investments from my taxable to my tax-deferred account. As part of this, I created a brokerage subaccount within my employer’s retirement plan for maximum flexibility. Finally, I moved all my international funds from my retirement account to my taxable account so I could claim the tax credit for dividends withheld by other countries.
5. Misjudging my risk tolerance. After learning about derivatives, I tried various options strategies to profit from my newfound knowledge. My favorite approach involved betting that the share price of a high-quality company wouldn’t decline more than 20% within the next few months. My hope was to make a modest profit if I was right, which was highly probable. The risk: If the stock performed worse than expected, I’d have to bear the additional losses.
Keep in mind that a single options contract involves 100 shares. If the stock price was high, like Apple back in 2012 when it soared past $500 a share, the maximum loss could be a real wallet-buster. At the time, Apple was a Wall Street darling, thanks to its meteoric rise in the preceding years. I got carried away and kept betting on its continued prosperity, despite the higher loss potential associated with its rising share price. The tide turned, and the stock began to drop from its peak. Suddenly, the possibility of a significant loss became all too real. Fortunately, I managed to pick up my penny and run before the steamroller got too close.
6. Expending too much effort chasing yield. I’ve always kept more cash than most financial gurus would recommend—something that helps me sleep better at night—but I got frustrated with the paltry interest rates that regular bank accounts offered. When high-yield savings accounts burst onto the scene and financial institutions were falling over themselves to attract investors, I couldn’t resist.
Before I knew it, I had opened numerous online accounts, constantly shuffling my money around to grab a few extra bucks in interest. Dealing with multiple tax forms each year and keeping up with the ever-changing rates became a headache—until I discovered a simpler way to get a competitive yield.
My brokerage firm lets investors participate in Treasury auctions and, at maturity, automatically reinvests the proceeds in the next auction. I promptly moved most of my cash into my brokerage account and signed up to invest in a few short-maturity Treasury bills. I no longer needed to juggle multiple bank accounts to squeeze out the last drop of yield.
Sanjib Saha is a software engineer by profession, but he’s now transitioning to early retirement. Self-taught in investments, he passed the Series 65 licensing exam as a non-industry candidate. Sanjib is passionate about raising financial literacy and enjoys helping others with their finances. Check out his earlier articles.
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I am compelled to refute the notion that a 401k Plan loan is always a bad idea. I made such loans as part of my job for some 14 years. I always advised those interested should also have a second readily accessible loan opportunity. Those alternate loan opportunities always came with less desirable terms making the 401k loan most appealing. One should also be able to continue to contribute to the Plan while paying down such loans. The amount has to be manageable at all times, an stable value allocation so to speak. I ran test scenarios regularly to demonstrate that responsible employees benefit from such programs.
Thanks for your note, jayne. You are right that in many cases, 401K loan can be a better option compared to alternatives available. At the same time, the opportunity cost (missing market gains) is also a factor to consider, especially if the market is down when the loan is taken, to avoid the “sell low buy high” situation if the market starts recovering while the loan is being repaid. The borrower should take an “informed” decision. In my case, I didn’t take a completely informed decision when I took out the loan, but once I took that factor into account, I decided to pay it off sooner than I had originally planned.
Loans from 401k plans, done right, are always a superior alternative when it comes to liquidity – where participants carefully evaluate all available liquidity alternatives, and, after determining the plan loan offers a better result than a loan from a commercial source, carefully manage the repayment process.
For example, a loan taken in the last 14 or so years typically had an interest rate that exceeded returns on fixed income options offered in most plans, AND, an interest rate that is typically less than what the individual would have paid on a loan from a commercial source.
As a result, in recent years, a plan loan, done right, has improved both the participant’s retirement preparation AND their household wealth.
Why didn’t that happen here?
Except for those individuals who allocate their 401k 100% to equity investments, a plan loan need not ever result in “opportunity cost”.
Loans are almost always fixed income investments. So, treat them that way – as fixed income investments within the asset allocation.
As necessary, rebalance your portfolio – treating the plan loan principal as the fixed income investment it is.
And, manage the allocation as the loan is being repaid.
Sanjib, I’ve made several of the same mistakes over the years. As for #3, the unwieldy portfolio, I didn’t get as creative as you so have less to simplify. On the other hand, you were able to declutter sooner rather than later and avoid big capital gains hits. In my case, most of the investments I’d most like to shed were acquired decades ago and I’m still wrestling with whether to divest and just pay the tax.
Thank you, Andrew. I still have a few clean-up to do – the preferred shares that aren’t called yet. Hopefully when the interest rate drops.
I’m in that club as well. Great article Sanjib.
Thanks, Michael. Good to know I have company :).
Just read 20th anniversary edition, Simple Wealth by Nick Murray. It will convince you not to buy individual stocks and it will lead you to control your BEHAVIOR; more important than any other factors
key word is “behavior”. Emotion is a major part when it comes to manage money. Do you know why some mutual funds always have a symbol of a sailboat or ship’s wheel ? It shown that their “captains” (read: fund managers) are calm and can “navigate” out of turbulent “sea”. Not all captains can navigate well (see also: Titanic).
Thanks neygen. I didn’t know about mutual funds showing symbol of sailboat/wheel. Makes sense when you come to think about it.
Thanks for the reference, Kenneth. Will look for it in the library.
Borrowing from my 401K was something I did far to often. I missed out on a lot of gains while I was paying back my loan.
It wasn’t very obvious when I took out the loan. Thankfully, I could repay it sooner and didn’t make the same mistake again.