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4 Dumb Financial Moves in the Recession

You can almost hear the collective slaps to the head.

AP

This recession has brought to light dumb money management practices, forcing just about all of us to confront our financial foibles.

Maybe, for instance, you're one of the ones who panicked and sold during the market bottom. Or, you believed housing prices were guaranteed to rise.

The federal government is tapping behavioral economists -- experts on why we humans make the money judgments we do -- to help devise regulations so that people don't take on unaffordable mortgages and to help them understand their actual credit card fees.

But these efforts just scratch the surface. Here are four common mistakes that surfaced during this economic turmoil, and fixes that we can put in place to prevent ourselves from making the same costly error again:

Regret 1: I didn't have emergency reserves.

Outsmart yourself: When we're confident about our security, stashing cash can seem like a waste. We'd prefer to put the dollars into a "better" use, whether it be sprucing up our home or going on vacation.

Last year, when the unemployment rate started soaring, so did the savings rate of suddenly scared Americans.

If you were one of those scrambling to build emergency reserves, you may abandon the practice once your fear subsides -- setting yourself up for another panic at the next sign of trouble.

So prevent yourself from slipping out of the savings habit by establishing an automatic withdrawal from your checking to a liquid savings. Moreover, if you instruct the bank to sweep a certain sum into a short-term CD when your balance reaches a prescribed level, you won't be tempted to raid the emergency stash.

"The idea is to create a mechanism that will force a habit," says Dan Ariely, a Duke University behavioral economist and author of "Predictably Irrational: The Hidden Forces That Shape Our Decisions."

If disaster does strike, there may be a small penalty to cash in a CD, but at least there'll be money to tap, says Ariely. Not all banking institutions may agree to automatically set up a short-term CD, however, so you might have to direct yourself periodically by putting the task on your calendar as a "must do."

Regret 2: I panicked when the market collapsed.

Outsmart yourself: Once a powerful emotion sets in, don't expect to overcome it, says Ariely. So head off the fear before it takes hold, he says.

When the market took a plunge earlier this year, Ariely says he personally took deliberate steps to block the reports of the Dow's dive. "I didn't want to look at my accounts online, so I input the wrong password three times. That locked me out," he says.

Don't listen to the business news, either, if that will rattle your resolve to hold your investments, Ariely adds.

Moreover, before an investment drops precipitously, you may want to set up alerts (many brokerage houses and financial Web sites offer this service) so that you receive an e-mail when a stock price drops to a certain level. Although he doesn't think most individuals know enough about a particular company to wisely invest in stocks, Eric Toya, a financial adviser based in Redondo Beach, Calif., says that these alerts could spur investors to talk with their adviser about keeping a holding that's losing value.

Regret 3: I greedily overinvested in a 'sure' thing.

Outsmart yourself: Studies have shown that the human brain's "wanting" system strongly activates when an asset goes up in value, driving us to buy more, says Paul Zak, director of the Center for Neuroeconomics Studies at Claremont Graduate University.

So even if you've sworn that you'll never again put the bulk of your wealth in a single asset, like a house or a stock fund, what's to stop your brain from getting excited when the next "big" thing rolls around?

Enlist your financial adviser, your partner or a trusted friend to dampen your excitement, says Michael Ervolini, head of the Boston behavioral finance firm, Cabot Research.

While a broker or financial adviser may not actually be able to prevent you from dictating that you'd like to sink your money in one investment type, you can ask him, even put it in writing, to dissuade you.

Cleveland financial planner Kenneth Robinson says his clients sign off on a written asset allocation plan, which helps them stick to the resolve to diversify.

And, says Ervolini, especially if you invest with a partner who has a vested interest in the success of your investment plan, establish a pact that you won't make moves unless you've both talked it over.

Finally, for those who can afford to set aside some "play" money, a separate fund can placate the desire to follow the hot trend without "betting the farm," says Zak.

Regret 4: I didn't read the fine print on my loan.

Outsmart yourself: If you're one of those homeowners with a mortgage that seemed cheap initially but has since proven ridiculously expensive, chances are "you were just following what you thought was acceptable wisdom" when you took the loan, Ariely says.

"Figuring out how to borrow is very complex," he says. Instead of delving through loan documents and plotting out just how much payments can rise, consumers are lured into complacency when they hear platitudes like "you can always refinance" or "if you're moving again in a few years, you don't have to worry."

Make a pact with a partner or friend that you won't take on debt without reading all the fine print, says Ervolini.

The federal government aims to make that easier with proposed reforms, like requiring a lender to give a one-page outline of a loan's risky features.

Still, complex loans will likely stick around. Ervolini says, "If you are not willing to read and really understand what a loan is all about, pledge that you'll go with the plain vanilla option."

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