When I set out to improve my financial knowledge, 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 on to 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 microcap 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 nonfungible 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
AAPL,
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.
This column first appeared on HumbleDollar. It was republished with permission.
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 on Humble Dollar.