Why smart people make bad financial decisions

Black Enterprise, Nov, 1994 by Gracian Mack

When the internal revenue service rolled through the gates at comedian Redd Foxx's Hollywood house some years back and confiscated all his personal belongings, down to his king-sized bed, people wondered, "How could he let it happen?"

This scene has been replayed over and over again. When Sammy Davis Jr. died, his widow cried broke. When Joseph Jett, former Wall Street trader at Kidder, Peabody, was fired and his accounts frozen, people wondered why all of his money was in one account. The answer is simple: Smart people can make bad financial decisions.

The late and great aren't the only ones who make financial missteps. For example, individuals whose holdings are all in short-term liquid investments may not be earning the best return in the long un. On the other hand, keeping all your holdings locked up in illiquid investments will prevent you from getting your hands on cash when unexpected needs arise.

According to an informal poll of investment professionals, the three most common mistakes in money management are: (1) Not taking enough time to do your homework. This includes researching who is going to handle your money, what kind of control over your finances you are going to retain and what your specific goals are. (2) Not taking advantage of obvious opportunities, such as the 401(k) employee savings plan at work. (3) Not adequately planning for the passing on of wealth.

Most people make, what we call in retrospect, dumb financial decisions because "They just don't know any better," says Willie Daniels, founder and CEO of United Daniels Securities in New York City (No. 11 on the BLACK ENTERPRISE INVESTMENT BANK list).

"Ignorance about what finance is, how the system works, what they specifically want out of the system, and how to maneuver through it, are all key factors," he continued.

Gwendolyn Kirkland, a certified financial planner with American Investment Services in Matteson, Ill., agrees: "I have people who come to me and say, |I want to make money.' Well, that is not enough. The first mistake is not having a written financial goal."

Without considering a specific time frame and acknowledging your capacity for risk, you compound your mistakes. Kirkland adds, "All of that should be discussed with your financial planner before you write a check and start to invest in anything."

BONDING WITH YOUR PLANNER

Not picking the right financial planner is another common mistake a lot of people make, Kirkland notes.

"It's a proactive process," she explains, "Like picking a doctor or shopping for a car, you have to talk to other people about the professionals you are considering."

In choosing a financial planner, you'll want to know how long they have been in the business and, most importantly, if the two of you are compatible in terms of style, goals and objectives.

Whether a full-service broker or a discount broker is better for you depends on how much work you're willing to do and what your investment goals are.

"If, for example, you are buying a mutual fund, you may not need the services of a full-service broker," Kirkland explains. "If you are willing to do the work [researching and individual stock watching], then a discount broker may be fine." But, she cautions, you'll be on your own. "You're giving up expert advice from a professional who knows you."

"Take the time to interview a broker or money manager," Kirkland strongly suggests. "After all, this person is handling your money. Don't you think you should have a personal relationship with him or her?"

The answer is a resounding yes, concurs Melvin Murray, director of claims at Atlanta Life Insurance Co. "Ideally you want someone, whether [he or she] is in the insurance field or in some other type of money management, who not only takes your calls and is responsive, but who will take time out to call you once in a while," Murray says.

IT'S NEVER TOO EARLY TO START

One of Murray's pet peeves is that people don't start investing early enough. "When you're in your 20s you're probably in the best physical condition of your life. You can probably get a suitable policy from any insurer. Your premiums will be lower and you will have a longer time for your savings to accumulate," he says.

"On the other hand, if you wait until you're in your 40s and 50s to get coverage and think that you are going to have a chance at accumulating wealth before you retire, it's going to be tough.

"The older you are, the more stringent your physical examination will be. The premium you'll be forced to pay will be much higher than if you had started earlier, and you'll have less time to accumulate any wealth," he concludes.

"By far one of the biggest mistakes you can make is not taking advantage of the 401(k) program at work," Kirkland notes.

"As soon as you're able to, it's almost a no-brainer to contribute to the maximum. Number one, the contributions are taken off the top [automatically deducted from your paycheck], so you're actually saving money that you never see. Number two, your employer usually matches your contribution."