By Jill Schlesinger, Tribune Media Services
Who among us has not made a costly financial blunder? Come on—admit it: we all make some dumb moves for which we have to pay a pretty penny. Research by the Consumer Federation of America found that two out of three Americans say they have made at least one “really bad financial decision.” The average cost was $23,000.
That we make financial boo-boos is not surprising, but the report also found that a large majority of those surveyed believe their ability to make financial decisions is “good” or “excellent,” despite having made costly financial mistakes in the past.
“Considering their past mistakes and the complexity of the financial services marketplace, we were surprised at how highly most middle class Americans rate their ability to make a variety of financial decisions,” said CFA Executive Director Stephen Brobeck.
Call it the “Lake Wobegon Effect,” named after the fictional town where author Garrison Keillor noted that “all the women are strong, all the men are good looking, and all the children are above average.” The Lake Wobegon Effect has come to mean the tendency to overestimate one’s capabilities. In social psychology, it’s called “illusory superiority.”
Of course, if we are all so smart and confident in the world of finance, why are we shelling out thousands of dollars to cover our bad decisions? Even if you from Lake Wobegon, you may be interested to know about these mistakes:
Failing to maintain an adequate emergency reserve fund. Maintaining six to 12 months of living expenses allows you to ride out many a financial storm without raiding your retirement assets.
Overly optimistic planning. From the mid 1990s until the financial crisis of 2008, too many people relied on annual investment returns of 10 percent. Those whose assumptions were more conservative faced far fewer surprises when the negative years rolled in.
Allowing your emotions to rule your financial choices. There are two emotions that tend to overly influence our financial lives: fear and greed. At market tops, greed kicks in and we tend to assume too much risk. Conversely, when the bottom falls out, fear takes over and makes us want to sell everything and hide under the bed. To prevent the emotional swings, create and stick to a diversified portfolio that spreads out your risk across different asset classes.
Assuming too big a risk. If you are going to make a risky investment, only allocate the amount of money you are willing to lose; that is, an amount that will not really affect your financial life over the long term. Yes, there are people who invest in the next Apple, but just in case things don’t work out, limit your exposure to a reasonable percentage (single digits!) of your net worth.
Not asking for help. There are plenty of people who can manage their own financial lives, but there are also many cases where working with a professional make sense.
Hey, I’ve heard that even in Lake Wobegon, the average financial mistake can cost you $23,000!