Investing Specialists

Learning From My Financial Mistakes

Christine Benz

In my early years on Morningstar's mutual fund analyst team, I absolutely loved the idea of Davis Funds' "Mistake Wall."

"We're in a profession that's very different from football," says fund manager Chris Davis in a video about the wall. "We should be getting better with age. We have the opportunity to gain experience, and from experience comes judgment, and from judgment comes investment wisdom. So we try to learn from the mistakes."

As a physical show of the firm's dedication to continuous learning and that all-too-rare commodity in investment circles, humility, the firm's offices feature framed stock certificates of investments that didn't pan out, along with a plaque noting the "transferable lesson" from the error. Davis notes that the lessons learned through mistakes had often paid for themselves--in the form of better results from other investment choices--many times over.

I think we individuals can learn from our own money mistakes, too, and become better investors and household financial managers in the process. In that same spirit of humility and continuous learning, I offer up some of the things that I could have done a better job with in my financial life.

Delaying IRA Contributions
Here's an area where I've been in the mode of "Do as I say, not as I do." Ideally, you'd make your IRA contributions as soon as you're eligible--at the beginning of each tax year--as doing so allows you to benefit from more months, and in turn years, of tax-free compounding. (I wrote about this last week.) In practice, my husband and I have been slow on the draw, usually sending our contributions in at the beginning of the year after the tax year that the IRA contributions count toward. There's no good reason beyond inertia and being occupied with other tasks. We can't deduct our contribution, so it's not like we're waiting to file our tax returns to find out whether our modified adjusted gross incomes qualify. Even more indefensible, we hold cash in our taxable account at the same firm where our IRAs are, so the process of moving from one account to the other is seamless; I could've gotten it done in the time it takes to queue up a show on Netflix! Here's an area where we're aiming to do better; I wrote about how to automate IRA contributions in this article.

Holding a Tax-Unfriendly Fund in a Taxable Account
Asset location--putting tax-unfriendly assets in tax-sheltered accounts and tax-efficient assets in taxable accounts--is a key concept for tax-efficient portfolio planning. From that standpoint, the decision to hold  Longleaf Partners (LLPFX) in a taxable account (or really, to hold it at all) was not a great one. Following a series of portfolio miscues, that fund's investors have been pulling assets from it for the past decade, and management has had to sell securities to meet redemptions. The result has been massive capital gains distributions in 2012, 2014, 2015, 2017, and 2018. Over the past decade, shareholders in the highest tax bracket have ceded 1.84% of their returns per year to taxes, and things look even worse over the trailing five-year period. Adjusted for the fund's 2.83% tax-cost ratio (yes, you read that right), shareholders in the highest tax bracket have actually lost money on an aftertax basis over the past five years, a period in which the S&P 500 gained nearly 12%. After paying taxes on a series of these distributions, we sold our Longleaf Partners position a few years ago. And because we had received a step-up in our cost basis because of the series of capital gains distributions, the sale didn't trigger a big capital gains tax bill. This article discusses how once you factor in the step-up in basis you receive on capital gains distributions, extricating yourself from tax-unfriendly investments may cost you less in taxes than you imagine.

Holding Too Much Cash
Sure, holding cash provides peace of mind, but it's possible to overdo it. Like being slow with IRA contributions, holding too much cash has an opportunity cost in upward-trending markets. While our IRAs and 401(k)s are fully invested and quite stock-heavy, my husband and I typically have been slow putting cash to work in our taxable account, often holding well more than we need for emergency expenses. There are a few reasons. While we've long used automatic investments to move money automatically from our checking to our investment accounts, we've been too conservative with those monthly contribution amounts. Another factor is that we've sometimes received lumpy influxes of cash (bonuses, and so on) that we've been slow in putting to work. In part because of the rapidly rising market that we've enjoyed over the past decade, it never seemed like a great time to do so. In hindsight, dollar-cost averaging out of cash and into our long-term investments (other than Longleaf Partners!) would have addressed that issue very nicely.

Putting Off the Long-Term Care Decision
My parents both experienced cognitive decline in their final years, an issue that I've written about previously. I've also tried to write regularly about long-term care, knowing what a huge wild card long-term care expenses are in many retirees' plans. So, you might assume I'd have this long-term care issue buttoned down. You'd be wrong. My husband and I contracted with an excellent hourly fee-only planner to help us decide whether and how to insure against long-term care expenses, and we discussed a few different options. A leading contender would be to convert our life insurance policies to hybrid life/long-term care policies; we're still mulling that. Alternatively, we could purchase a pure long-term care policy, paying premiums with taxable dollars or even the assets in my health savings account. Another option would be to continue to put the maximum allowable annual amount into the HSA, invest the assets, and let the account build into retirement. That's the route we're taking for now, though it's unlikely we'll be able to build a sufficient bulwark against long-term care expenses before retirement using just that account. We realize we should make a decision on this front soon, because the longer we wait, the more likely we are to encounter some type of disqualifying health condition for purchasing pure long-term care insurance. But for now we're like many of you--paralyzed by indecision and overwhelmed by how imperfect the available options are.  

Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.