The Impact of Financial Mistakes
“I think making mistakes and discovering them for yourself is of great value, but to have someone else to point out your mistakes is a shortcut of the process.”
Owning Up To Financial Blunders
Have you ever made a big financial mistake? You’re not alone. According to a Consumer Federation of America report from 2012, 67% of middle class American consumers (those with annual incomes of < $100,000) owned up to a “really bad financial decision”, resulting in an average loss of $23,000.
And apparently, having more money doesn’t automatically make you smarter! Among upper income Americans (yearly incomes of $100,000 or more), 61% confessed to making a fiscal misstep. The average loss for this demographic was $61,000, 265% more than their middle class counterparts.
One of the report’s most telling details is that over 80% of those surveyed felt that their ability to make financial choices was “good” or “excellent”. However, there was an overwhelming correlation between losses and the lack of professional financial advice. A full 17% of middle class respondents said they “wouldn’t seek any information or advice, and just make a decision,” yet this group fared worse and suffered more losses than those who sought professional help.
If four-fifths of those responding are “good” or “excellent” at making financial decisions, then why have nearly two-thirds admitted to making a bad choice – with nearly half saying they made more than one? There seems to be a serious disconnect here.
Measuring Long-term Losses: Opportunity Cost
Bad financial choices might result in an immediate dollar loss, but there is a lingering impact called opportunity cost. An opportunity cost is what that money could have earned over time – had it not been lost.
To give some perspective, let’s say a poor decision at age 40 causes a shortage of $50,000. Since life expectancy is just shy of 80, the period of opportunity cost would be almost 40 years. Using a 5% annual rate of return, the eventual opportunity cost would be a seven-fold increase of $351,999.
Of course the real opportunity cost could be higher or lower, as rates of return are variable, but the point remains the same: the cost of lost money is ongoing, not a one-time event.
Keeping the opportunity cost in mind, here are some further observations:
How to Avoid another Financial Mistake
Don’t be a Lone Ranger—open yourself to seeking and accepting advice from those you trust and keep on growing your financial IQ. Keeping an open mind will allow you to see unique perspectives and potential blind-spots and avoid unwanted financial mistakes.