“Only two things are infinite, the universe and human stupidity, and I’m not sure about the former.”
–Albert Einstein (pictured, and not stupid)
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
–Charlie Munger
Human beings can be pretty stupid—about money and a lot of other things.
For instance, I enjoyed hearing about a case of three men who burglarized a restaurant. It turns out they stole cash and also took some pasta salad as a snack. They were hungry—and messy. The police just followed the trail of spilled pasta right to where they lived. Case closed.
Or, I think about another case of robbery, this time at a home improvement store. The thief made his getaway by jumping a nearby fence–and had apparently outwitted the police. Unfortunately, it turned out he had leaped onto the grounds of local a nudist resort. Since he was only one clothed in the entire place, he was easy to pick out as the perpetrator.
But you and I are not that stupid are we? Instead we are careful, especially about our money. We plan ahead, consider consequences and are rational. We would never jump a financial fence unless we knew what was on the other side, right?
AVOID THE FOUR FINANCIAL PITFALLS
Unfortunately, many people make equivalent financial mistakes, and worse.
And yes, the successful make mistakes too.
What follows are the most basic issues that usually lead to trouble. It is not that complicated. For a list based on more complicated and subtle errors see this.
Now, some kinds of economic mistakes do not appear to be a problem at first, even the basic ones covered here. However, there are at least four common pitfalls/characteristics that are hard to avoid because some behaviors:
- Carry very high actual costs which appear to be negligible at first but are deadly later
- Have economic consequences (i.e., they seem to have no financial impact, but do);
- Cause permanent damage, sometimes after only one tentative step, and
- Are pathways to various forms of addiction. People lose control of their lives, futures, and money.
So, eliminating mistakes is vital.
Can that be the key to life and financial success? Don’t be stupid? Is it really that simple?
No, but it is far more important than we care to admit.
Therefore we are going to talk about what situations and habits to avoid, and how people who are financially successful do so. When the data are available, the negative impacts are summarized. Most of what you will read is about everyday habits—not life-changing events. That is why many people underestimate the pitfalls.
But I am going to apologize in advance. At times my tone will sound like that of an annoying Sunday school teacher. Sorry. It is not meant to be preachy.
ERROR 1: GAMBLING
Ok, first a confession: I spend maybe $20 on Powerball every year. It is entertainment, it is fantasy, and yes I do it a little.
I enjoy gambling action. However, whenever I get a real craving, I just gaze at one of those paintings of dogs gathered around the table playing cards. It costs less than real gambling.
So, maybe I am the wrong person to deliver this message. Maybe you need someone who NEVER gambles and is not tempted to either. However, people who are financially independent seldom play games of chance—less than 25% do. The research from Dr. Stanley (Millionaire Next Door) is consistent, as are studies done since.
But, you may say, haven’t there have been famous extremely wealthy people who gamble? Yes, there have, but they are the exception. Bill Gross, a billionaire, made a fortune in the bond market and financial services industry. But once, long ago before his current career, Bill spent a summer as a professional gambler playing blackjack. But blackjack is one of the few games that you can consistently win at if you are a very skilled player. Winning is not about random chance at all.
The financially independent
DON’T take random chances. They have a long-range perspective and a passion for preserving and making their capital grow. If they do make a bet, it is usually a calculated one. A quote from Mohnish Pabrai about one preferred strategy is, “Heads I win, tails I don’t lose much.”
You see, they use a defensive strategy because tragedy can happen to people who do gamble. According to one estimate, there are about six million people in the U.S. that have a form of gambling addiction that requires treatment. Many are broke, in debt and have sacrificed their families and loved ones.
When random fortune does smile on gamblers, random money management is also not a strategy that helps them keep what they win. According to one source, about two-thirds of lottery winners later declare bankruptcy. So, trusting to luck is neither an unmixed blessing nor a way to keep money.
ERROR 2: SPENDING ADDICTION
Many years ago Imelda Marcos, the wife of a Philippine dictator bought 3,000 pairs of shoes. Needless to say, no one can wear that many. If she had worn a different pair each day, it would take eight years to wear them all.
Apparently she could not control her desire for even more shoes. Of course, it did not matter to her. After all, when you steal a country blind, the cost of purchasing shoes is no object.
As the fourth leading cause of bankruptcy, overspending and spending addiction do not get the press that other destructive behavior does. And, in the case of Imelda Marcos, it can cause derision. But, let’s not understate how serious this issue actually is.
Any addiction, whether it is to spending, drugs, or something else is always bad. Ultimately the addict gives up control over his/her life.
We generally think of spending addiction as being less harmful than drug addiction. That is because the primary victim is the person’s bank account and not their health. Of course, that logic discounts the damage done to family relationships from avoidable poverty.
The causes are of spending bankruptcy are many. Here are just a few. People don’t:
- Pay attention. It is essential to know where your money is coming in and where it is going. Sometimes people wake up one day and are broke. They never saw it coming.
- Grasp the value of both saving and spending. If you go to enough sales to “save” money, you can end up overspending. It is important to understand addition AND subtraction.
- Understand that keeping up with the Joneses can have disastrous consequences. After all, if the Joneses just make more money, you cannot “win” the contest. Many people blindly run down the same rabbit hole as the (sometimes broke) Joneses. Imitation is the sincerest form of flattery, but you may end up flattering someone who has no judgment at all.
- Know that being envied has a downside. This is a lot like pretending. If you do not actually have more money than others, outspending them will eventually make you go broke. People who are broke are seldom envied.
- Grasp behavioral problems. Some people are just compulsive and cannot help what they do. Or they get insane levels of pleasure from spending. While they may get a high from spending, their creditors are intoxicated too—as long as they get repaid. Sooner or later they do not.
- Take the time to understand the commitments they make. For instance, some kinds of loans and credit card interest payments can actually inflate the cost of items purchased by 2-3 times due to extremely high interest costs.
- Understand the difference between a want and a need. For example, I want a $200,000 luxury car. I need what I have—a reliable, cheap form of transport with 120,000 miles.
- Realize they are addicted. It is a serious problem and no laughing matter. Extensive counseling and therapy are needed.
The wealthy are not immune to these behaviors. I know of several who made and then lost fortunes. When they lose a fortune overspending is often a culprit.
ERROR 3: THE TWOFERS
Twofers are habits that cost heavily now, and even more when the full health impacts come later. And those two budget impacts are far worse than one. Expect “twofers” to make you go broke, and worse.
You see, twofers are mistakes that last a lifetime. That is why I have listed this part last—it is the worst of all possible worlds. While gambling and spending addiction will kill your bank account, twofer habits can destroy your health too.
The first most studied twofer, as you may have guessed, is smoking. Smoking literally creates a laundry list of significant health problems: cancer, heart disease, high blood pressure, and other issues. People in our family have died from lung cancer.
So, by and large the wealthy avoid it for both health and financial reasons. A Gallup poll in 2008 of over 75,000 Americans confirms this. At that time the smoking rate of those making near minimum wage was more than twice that of those making $90,000 per year.
Since this is a financial blog, let me give you the bottom line too. According to a study by Professor Jay Zagorsky non-smokers have approximately HALF AGAIN MORE NET WORTH than light smokers. Nonsmokers roughly double the net worth of heavy smokers.
What, you may say? How can that be? How can this one habit have such a high financial impact? Well, let’s look at the direct costs first. Suppose you are a pack-a-day smoker. And suppose a pack costs $7 per day including taxes. That is over $2,500 in expense per year. That does not take into account ruined clothing; extra cleaning costs etc. so, let’s say the price is actually $3,000 per year. At this writing that is about 5-6% of national annual average family income. If you are a heavy smoker and smoke two packs a day, double that. If you are in a long term relationship and you both smoke heavily, add more.
But that is not even the expensive part. Nope, as a twofer, the massive hit to your finances comes later.
Smoking can cause serious health problems that curtail your career. No career, no job–no salary. And that is really expensive. Health costs are astronomical and the number one cause of bankruptcy.
And then there is drug and alcohol addiction, which is often far worse. The same fundamental financial problems and expenses apply–except you may be able to double the cost AND problems. Addicts just do not die wealthy. They tend to die early.
SUMMARY:
1. Gambling, drugs, smoking, and overspending are risks to your wealth. Don’t do them, or put yourself in a position where they may tempt or hurt you.
ACTION PLAN:
1. Don’t buy things you don’t need and don’t use.
2. Understand what you spend.
3. Don’t buy things and services that harm you.
4. Avoid any activities that carry the risk of addiction.
Disclaimer: consult with a financial professional before taking any steps outlined here. Not all advice may be suitable for your circumstances or investment style.
Photo credit (cropped): Simonroche. License