Over the years, I’ve seen some brilliant people make really stupid money decisions. That’s why I was excited to see Jill Schlesinger’s new book, The Dumb Things Smart People Do with Their Money. Schlesinger, a business analyst at CBS News, lists 13 dumb moves and ways to right these financial wrongs. Let’s look at three of them.
1. Buy financial products you don’t understand.
I review annuities, hedge funds, private REITs, alternative investments and the like. The more complex the investment, the worse it typically is. I point to the thick product disclosure document and say, “I promise you that the lawyers and the actuaries didn’t write this document to protect you.” These products are often easy to buy but very costly to get out of, if you even can.
Simple products are typically superior. I tell people not only do they need to understand what they are buying, but if they can’t explain it to any 8-year-old, they probably shouldn’t buy it. Stick to simple investing. In an interview, Schlesinger said the larger the disclosure document, the more important it is to thoroughly understand.
2. Take on too much risk.
Our willingness to take on risk is not stable. When markets are going gangbusters, we think we have a high risk tolerance. It’s only when they plunge that we realize we were wrong. The research of Daniel Kahneman, the first psychologist to win a Nobel Prize in economics for his work in behavioral economics, revealed that we get twice as much pain from losing money as pleasure from making that same amount.
Because the bull market is nearly 10 years old, and the 2008-2009 plunge a distant memory, we forget the lessons from the bear and tend to think we are very risk tolerant. Even advisers took on too much risk, only to turn to cash after the plunge.