How Smart People Make Dumb Financial Mistakes (so that it doesn’t happen to you!)

It seemed like a smart idea at the time…

I sold the hedge fund business and became financially independent at age 35. What’s wrong with that?

After all, it bought me the freedom to embark on a 6 month trip and live the dream I had put off since college – long-term travel through the Middle East and Europe with nothing more than a backpack, credit card, and no worries in the world. My whole life lay before me as one grand adventure.

Seriously, I have no right to complain.

Yet, it was one of the worst financial mistakes of my life. It cost me millions – many millions of dollars. I was so caught up in living my dream that I lost all financial perspective.

I had no idea at the time that I had just followed the classic recipe for a foolish expensive financial mistake, but I was about to find out the hard way. Hopefully these lessons will help you avoid doing the same.

What Causes Financial Mistakes

In a perfect world there would only be two causes of financial mistakes – bad information and flawed reasoning.

If humans were perfectly rational with accurate programs in our heads we could take the information provided, process it to an accurate conclusion, and consistently make smart financial decisions.

I wish it was that simple. However, it doesn’t work that way in practice. We don’t live in a perfect world and our brains don’t work like perfectly programmed computers.

Sometimes we get bad information that diverts our thinking with inaccurate inputs. Or we use incorrect information to conclude something that is actually a half-truth but inadvertently becomes a whole truth. It becomes THE TRUTH when, in fact, it is not.

My personal experience is the bad information problem, while appearing significant on the surface, is a relatively small factor in the really bad financial decisions that I’ve blundered. Rarely have my financial mistakes been driven by bad information. I would consider the information issue a relatively minor problem easily solved by due diligence.

More insidious is the bad reasoning problem because we humans aren’t rational computers. We make decisions emotionally and support the decision through rationalization. The ability to rationalize a bad decision knows no boundaries and is remarkably insidious. I say this with deep humility having observed my own decision process for decades and coached hundreds of clients through the same. Nobody is perfect. We all make these mistakes, including you and me.

For example, my own decision to sell the business was driven by my emotional attachment to living my dream of traveling the world free as a bird with nothing more than a backpack and a credit card. I was so attached to that dream that I rationalized selling the business for less than it was worth under the delusional premise that this action was necessary.

It wasn’t, and that was a critical error.

The truth was I slaughtered a valuable cash cow business for a few pounds of hamburger when I should have savored the sweet milk it produced for decades into the future. This mistake cost me millions of dollars – literally.

I was blindsided to alternative ways of viewing the situation by my narrow focus on my dream. My reasoning became one dimensional. My analysis was polar: the classic prescription for a bad decision. Somehow I got in my head that if I wanted to travel the world I couldn’t do it while working in the business; therefore, I had to sell it. Wrong.

It never occurred to me to hire and train staff to run the business in my absence so I could retain the income and still enjoy my freedom. Oops. Or I could have hired another money management company to take over day-to-day operations giving me the freedom I desired while still retaining ownership. Double oops. There were many possibilities. I just couldn’t see them. I was blind. That is how bad financial mistakes are made – blindness.

The point is I got distracted by other competing goals (my dream of world travel) and failed to focus adequately on managing the financial implications of the decision properly. My flawed reasoning allowed the sale of the business to become an “either/or” decision when it was nothing of the sort. Either I sell the business or I don’t live my dream of world travel. Nonsense! There were many ways I could have lived my dream and kept the business. I just didn’t look for them because… well, I wasn’t looking.

Here’s More Examples

As it turns out, my financial mistake is not an isolated example of this problem. In fact, it is quite common. It’s the most common way we make foolish blunders so please pay close attention and don’t follow in my footsteps.

While there’s no definitive research providing hard data, anecdotal evidence from my work with hundreds of financial coaching clients tells me the number one cause of the truly expensive, large scale financial mistakes is conflicting goals causing you to not properly weigh the financial implications of your decision.

For example, every day there is someone who accepts an offer to sell his home far below value because he isn’t getting any better offers and has conflicting needs to either move or get out from under an oppressive mortgage payment. The desire to get on with his life is rationalized as the reason to sell below value – sometimes at absurd prices. Many times I’ve been told of people who accepted a lowball offer out of desperation only to hear someone tell them they would have paid more if they had any idea they were willing to sell that low. There are always alternatives.

I know of bloggers who have sold their successful web sites for 1-3 times passive revenue (advertising, etc.) when the financial aspects of this decision made no sense. The reasoning will be familiar by now. They were either tired of writing and wanted to move on, or they were tired of dealing with the technology, marketing, and other backend issues related to the business and just wanted to focus on writing. Seldom is the discussion about financial considerations. Finance is pushed to the background because the focus is dominated by personal motivations, and therein lies the problem.

Another example is the coaching client who comes to me in need of an investment plan after making a series of horrendous investment mistakes causing massive losses. What has surprised me is how many of these investors have succumbed to the life insurance salesman’s pitch. “At least you won’t lose this one: it will always be there for you and your family.” True, but at what cost. It is a distracting half-truth appeal that blindsides the investor from seeing more effective and efficient solutions to the problem. They are perfect prey for that pitch because their painful loss blinds them to alternatives.

I could continue on with many examples but you get the point. When you have conflicting motivations behind a decision it is very easy to overlook important financial considerations. The result is an expensive mistake.

However, when you focus on financial considerations the decisions are usually sound… at least from a financial viewpoint.

How To Minimize Financial Mistakes

There are two ways to minimize financial mistakes:

1. Educate Yourself – That is what this site is all about. As you improve your financial intelligence your reasoning skills will improve. You will develop a good nose for sniffing out financial nonsense. Due diligence skills will help you overcome information problems. The rational part of your brain will be driven by software that applies proven principles. All of this will result in better decisions.
2. Focus On Financial – Develop self-awareness that notices when conflicting goals are narrowing your field of vision. The goal is to always catch yourself getting sidetracked before making an important financial decision – not after.

Over the years I’ve improved on both fronts. My motivation is strong because I know how much these mistakes have cost me. Given my financial background, I’ve reached a point where distraction is my most dangerous enemy causing multiple bad financial decisions in my life. It has literally cost me millions not just once – but several times. In other words, this idea may sound simple but I can’t overstate it’s importance. Seriously!

Yes, even financial experts make horrendous financial mistakes. I’m living proof that it is remarkably easy to do when you allow your mind to get distracted by competing goals. It is one advantage to having a financial coach as a collaboration partner. Your coach is not distracted by your emotional needs like you are.

Learn from my mistakes. Train your mind to properly weigh financial considerations and look for alternative possibilities when your field of vision is getting narrowed by conflicting objectives.

When you balance the decision you’ll nearly always discover alternative solutions so that you can have your cake and eat it too. It doesn’t have to be “either/or”. You can have both when you open your mind to seeing the alternatives.

Now it is your turn. Come clean with your favorite financial blunder in the comments below. Owning it helps you grow beyond it and helps everyone else learn from each other’s mistakes. Share your experience below and let’s all benefit…

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