Tuesday, December 22, 2009

Don't Stay The Path If It's The Wrong One

Tip #217 - Don’t Stay The Path If It’s The Wrong One. Have you ever started a project such as painting your living room and as you watch the paint go up on your walls you realize that the color is all wrong? But because you just bought two gallons of the stuff and you've already invested 45 minutes into the project you think maybe, just maybe it will be okay, and you keep forging ahead with the same paint color that you don’t care for? A week goes by and you realize you really don’t like the paint at all but now you tell yourself that it was several hours of hard work over a couple of days and you're not going to do anything about it now and decide to live with it. Years go by and you finally decide to repaint the living room and announce to anyone who is in hearing distance, “I should have done this a long time ago. I’ve always hated this paint!” You repaint the living room and love the new color and all is well except the several years you lived with a paint color you hated.

Well, finances are like that, too. We make decisions such as investing in a CD that comes due in five years. Or we put our money in a stock hoping it will go up over the next 3 years. Or we pick a bank that is convenient for us to bank with. And sometimes after we make the initial decision we realize we made the wrong one. But what do we do about it? Nothing. We live with the consequences of not making any changes even thoug we know the initial decison wasn't necessarily the best for us.

For example, we buy a 5-year CD for $1000 that is paying a 4% rate. We realize after 3 months that 5-year CDs are paying a 5% rate at a neighboring bank. We can cash out the original CD for just the penalty of interest paid so far ($10) and invest in the new CD that will earn us $250 over the course of the 5 years (assuming no compounding) versus $200 for the original CD. So for the cost of $10 you will earn you an additional $50 or a net of $40. Now $40 might not sound like a lot. But what if it was a $10,000 CD, and we’re talking about the difference of $400? Why not go for it? Why stay the wrong path just because at the time it was the right one?

How many times have you invested in a stock or mutual find thinking it would be a good one only to find out month after month or year after year that it’s just not performing to expectation? But you keep the money in that stock or mutual fund because you initially had high hopes for this particular stock or you keep it in there because it’s gone down in value and you don’t want to sell it until you’ve made your money back. The phrase, “cut your losses and move on” comes to mind with this example.

Lastly, suppose you choose a bank that is down the street thinking you can walk there any time and that the convenience outweighs other factors. But after banking there for a couple of months you realize that the tellers aren’t very friendly and the rates aren’t competitive. And frankly you drive by three other banks on your way home from work five days a week that you can stop at just as easily. But you never bother to switch banks because your direct deposit is set up with them and it’s a hassle to go through the paperwork of opening up a new bank account again. So you stick with a bank that you don’t like. And when you finally do change banks years later when you finally have had enough of the bank you don’t like you realize it’s the same amount of work to change banks now as it would have been to change years ago. And you would have saved yourself a lot of heartache and unhappiness if you had done it much earlier.

I don’t know why humans are like this, at least some of them anyway. Once we make a decision about something we have a need to follow through with our decision even if we realize it was a wrong one. It’s as if we can't admit to ourselves that we may have made a bad decision. I know I do it, and I’m sure others do to. But let’s stop that behavior. When we realize something can be improved or changed, then let’s change it. Why go down the wrong path just because at some point we thought it was the right one? If it will improve our bottom line or the ease with which we’ll get there, then make the change. You’ll probably change it eventually anyway so why not take full advantage of benefits by make the changes early on?

In Real Life (IRL) – In our family's efforts to review our finances before the end of the year, I was looking over some CDs (share certificates) that we own in our credit union. At different times we have rolled over money sitting in a regular savings account into a certificate to earn a higher interest rate. And we have also taken advantage of some 1-year specials they have had with much higher rates than their normal certificates. As some of these certificates roll over (become renewed) they may not get a competitive or special rate the second time around. When I looked over our CDs recently I noticed two in particular that were earning less than 1% interest, and they were 3-year CDs! What a terrible rate. One (worth about $500) had renewed in April and one (worth about $700) had renewed in October. I missed the renewal notices that were sent out because these particular ones were set up by my husband and the notices went to him. As he doesn’t have as much interest (read obsession) in finances as I do, I guess he ignored them. In any case, the interest being earned on these CDs stunk. And I realized this same credit union is offering 3-year CDs (really share certificates) that are paying 2.2% as long as we invest at least $1,000.

At first I was tempted to do nothing (the easy course) because I figured they were small dollar amounts, and we could just make the changes when they came due in 2 ½ to 3 years. But then I did the math. I checked the policy on cashing out a share certificate and found out the penalty is the amount of dividends paid to date since the renewal (or in the past 180 days, whichever is less). That amounted to about $4 in our case. By keeping the money in their current CDs, we would earn about $36 (not even) over the course of three years. By switching them to the minimum $1,000 CD, we would earn more than $79 over the course of 3 years minus the penalty it cost to switch, which was $4. So we would earn more than $75 with the new CD versus less than $36 if we kept the course. Now, it’s a small dollar amount difference for sure. By switching we would have an extra $39 dollars in our pocket in three years. But you know what it took to make that extra $39? A phone call that lasted not even 5 minutes. Believe me, I was tempted to do nothing because the amounts were so small. But when I looked over all of our CDs at that credit union, they were all getting relatively good interest rates except for those two, and it was bugging me.

By paying a penalty I was admitting we made a mistake initially, but the outcome was so much better. I wronged our mistake and we are on the right course again – earning a better interest rate and leading to more money in our pocket by cutting our losses early on. What is keeping you from changing the course of some of your paths that might not be the right ones?

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