Decisions shouldn't be judged on their results. The future is uncertain, so decision results will always be mixed. Even the most sure bet, the one that is going to win 99 of 100 times, loses once in a while. That doesn't mean the decision was wrong if clearly the alternative was incorrect.
We should judge decisions based on an assessment of the risk and potential reward. If the risk and reward is assessed properly, the lowest risk and highest reward choice should be made to put the odds in your favor. Then, over the long term, there will be more wins than losses and you'll be better off.
With this criterion, let's look at the worst financial decisions of 2009 starting with individuals and then moving on to our leaders.
Decisions By Individuals:
- Running Up Credit Card Debt
This always tops the list of poor financial decisions. But it's like the warning on a pack of cigarettes saying they cause cancer - many people just don't listen. In terms of risk and reward, this is a killer. The return is some level of current comfort, usually not dire necessity. The risk is that you won't be able to pay the bill in the future, especially as this debt compounds with high interest rates, resulting in your bankruptcy and financial ruin.
It's difficult to reconcile that huge of a risk with seemingly harmless behavior such as going out to dinner, buying some music or just maintain a lifestyle, but it's true.
In an economic crisis, borrowing to facilitate a lifestyle of days gone by makes the odds of very poor future lifestyle significantly higher. The risk simply isn't worth the reward. (Avoid these pitfalls to keep your credit score healthy and your debt under control. Learn more in 6 Major Credit Card Mistakes.)
- Getting Out Of The Market In A Panic
As stocks fell early in the year, panic gripped the market. Seasoned investors like Warren Buffett were giddy with the prospect of sale prices on many firms. Average investors were fearful and ran for safety. The risk in the market is far higher at peaks than valleys, so getting out only feels safer. Now that the market has regained some of its losses, there is less opportunity to recover your own losses.
The decision to get in or out of the market should have a foundation of getting in at the bottom and out at the top, not the other way around. Once the downward slide is well under way, the odds favor hanging on through the volatility, rather than risk getting out and missing the recovery. (This esteemed investor rarely changes his long-term investing strategy, no matter what the market does. Don't miss Warren Buffett's Bear Market Maneuvers.)
- Not Continuing To Contribute To Your 401(k) or IRA
When times get tight, lifestyle changes can be painful. To avoid this pain, some have stopped contributing to their 401(k) and IRA. It may feel like you need the money, but tightening your belt is a far lower risk and higher reward than stopping your 401(k) contributions. Those that continued to contribute to their retirement had little risk as they bought into the market at low levels, and the rewards they gave up, like a bit more spending money, pale in comparison to longer term reward of a sound retirement.
Decisions By Politicians:
- Not Front-Loading The Economic Stimulus
With unemployment in double digits and much of the stimulus package passed early in the year still not in the economy, it's clear that the strategy of a multi-year economic stimulus isn't working. But that's not why it was a bad financial decision.
The risk of dragging out the stimulus is that the economy won't recover fast enough, and when it does recover and we need to slow it down to prevent inflation, the stimulus will be harmful. The reward for dragging it out isn't clear. Why would we want to stimulate the economy several years into the future in the middle of a financial crisis? This is a high risk, low reward decision.
- Not Jumping On Financial Regulation While There Was Momentum
There needs to be changes in the financial system in several ways. One would be to remove or mitigate risks such as too big to fail banks. Another is to align the rewards given to corporations with those that are taking the risks. But to push this debate and these changes off into the future is a high risk, low reward strategy. (These indicators can illuminate the depth and severity of problems in the credit markets. Check out Top 5 Signs Of A Credit Crisis.)
The risk is that meaningful legislation won't pass as public outrage wanes and there is little to no reward for waiting unless you assume nothing should be done. Making changes is a great risk and reward strategy for those that would be opposed to preventing further crises.
The Bottom Line
The quality of these decisions isn't based in the results. Good decisions don't always put off poor results and bad decisions sometimes hit the jackpot. Measuring their results shouldn't be based on monetary gain, but rather if the odds were in our favor. In these cases, the risk wasn't worth the reward. Going forward, it's how often we put ourselves in low risk, high reward situations that will matter.