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The Best Interest » 5 Common Failures in Personal Finance

5 Common Failures in Personal Finance

This recent episode of Freakonomics shares an important lesson: 

People tend to think of tragedies and failures as single moments of error. But that’s wrong. Instead, we must realize that every failure is a chain of events. There are multiple inputs into a failure. Thus, a “failure chain” can be interrupted or diverted at many different points.

selective focus photo of black metal chain

As an example, Amy Edmundson of Harvard Business School writes of drug dosing failures at hospitals:

“The natural tendency is just to look at what they call in hospitals ‘the sharp end,’ or at the last person, the person at the bedside who administered that drug. But in fact, the chain of events goes back to the pharmacy, and even to the I.T. folks who printed the label in a weird way.”

Here on The Best Interest, one of my odd go-to topics is fire. Fire safety, how fires spread, fire tragedies, my parents’ neighbors’ house catching fire, etc. Considering one of the biggest personal finance acronyms is F.I.R.E, it’s an odd coincidence.

In my amateur study of fire safety, the “chain of events” is clear. There’s never a solitary reason explaining a fire death. There is always a chain of events. If any of the links on that chain were different, tragedy would have been avoided. 

Think about it. With any fire death, you should ask questions like:

  • What started the fire? What went wrong to create that initial spark? 
  • How were individuals not alerted to the fire? Were there sufficient alarms? 
  • Was there a chance to extinguish it early, with handheld extinguishers or a sprinkler system? Or were those systems lacking? 
  • Was a fire evacuation plan in place? Was it practiced via fire drills?
  • Were other safety codes being violated? Was the building overcrowded? Were doors locked? etc
  • Were the victims reasonably healthy? Were they in a sound state of mind? 
bonfire photo

When these answers align in a negative way, a tragedy occurs. But if any one answer is different, the worst outcomes can be prevented. 

Inspired by this line of thinking, I wanted to examine…

  • What are the biggest sources of personal finance failure?
  • What should you be doing in your life to avoid such failures? What questions can you ask right now? How can you “break the chain”? 

Failures of Measurement

Most of the biggest, simplest, and most painful mistakes in personal finance are caused by failures of measurement. As Peter Drucker says, “You can’t manage what you don’t measure.” Measuring your personal finances is fundamental to success. 

As an example: very few people intentionally self-destruct into consumer debt. Instead, they unknowingly slip into debt hell. Without measuring their spending, they weren’t aware of the slope they were slipping down. 

Specifically, I suggest measuring “the big four:” 

  • Income and expenses (i.e. via a budget, updated monthly)
  • Assets and liabilities (i.e. via a net worth statement, updated quarterly) 

The question to ask is, “What, precisely, is happening in my personal finances right now?” 

shallow focus photography of gram scale

Failures of Understanding

It’s hard to know everything. Thus, we all suffer failures of understanding. But as Mark Twain said,

“It ain’t what you don’t know that gets you into trouble. It’s what you know that just ain’t so.”

Example: an acquaintance of mine is positive that his annuity is a great decision for him. [Narrator: “It’s not”]

He would be easy to help if his lack of understanding was, “I have no idea what I’m doing…” Instead, he’s positive he’s right! [Narrator: “He’s not.”]. With heels dug in, his failure continues. 

The question to ask is: What is the world actually like? How might my assumptions be wrong? 

Failures of Planning

Some aspects of the future are knowable. We know we’ll grow older. We know many aspects of personal finance change as we age. We know we should plan accordingly.

white moon on hands

But we don’t always do so, leading to failures of planning.

As an example, required minimum distributions (RMDs) are a known quantity in retirement planning. RMDs are mandatory withdrawals that individuals with certain tax-advantaged retirement accounts, like Traditional IRAs and 401(k)s, must make once they reach a specific age, typically starting at 72. 

The Federal government wants its tax money. RMDs ensure that happens. 

What happens if a retiree already has a healthy retirement income? Can they postpone the RMD? Nope! Their RMD occurs anyway, incurring taxes at a high marginal tax rate. Ouch. 

Good tax planning mitigates this problem. 

The question to ask is, “Based on what I know today, what should I be concerned about in the next 1, 5, 10+ years?” 

Failures of Imagination

Failures of planning deal with known facts. Failures of imagination deal with unknown facts. The classic saying is “You don’t know what you don’t know.” It’s hard to imagine the unknown.

Nobody knows how the investment markets will perform over the next 1, 5 or 10 years. If anyone knew for sure, they’d be able to leverage that knowledge into billions of dollars. This fact – that market performance is unknown – is the precise risk that creates investment reward. Without the unknown, investing would be fruitless. 

dreamy woman standing against blue background

But we do know what’s possible. Simply look at market history. 

  • Is it possible for a 100% stock portfolio to lose 50% of it’s value? Yes. 
  • Is it possible for a single stock investment to go to zero, because the underlying business goes bankrupt? Yes
  • Is it possible for a diversified stock/bond portfolio to go to zero, or even lose value over long periods of time? No (unless there’s an apocalypse, in which case the only important things are bullets and beans)

PS – if I ever start an apocalyptic preparation podcast, it will be called “Bullets and Beans”

Lacking a simple emergency fund is another failure of imagination. Can you imagine a tree falling on your roof? Good. You should have an emergency fund

The question to ask is: What’s possible?! What could possibly go wrong? 

Failures of Risk Management

Our finances can be a risky business. That’s ok, as long as you understand the risks.

Planning and imagination typically do a good job of identifying risks. The next important step is to quantify those risks, then mitigate them or protect against them. That’s risk management. 

man climbing on rock mountain

A basic example: any insurance that you own. Insurance is protection against a risk that you otherwise couldn’t protect against. 

The question to ask is: How bad are the consequences? And how can I protect myself from those consequences?

The five “failure modes” described above often synergize into painful personal finance failures. But plan, understand, measure, imagine, and de-risk, you’ll surely break the failure chains that are tying you down.

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