Don’t Create a Rule, Learn a Lesson

Nobody wants to spend their life continuing to repeat the same mistakes. But we also have to remember that just because we had an experience, good or bad, one time, that doesn’t mean that we should necessarily alter our course.

In terms of personal finance and investing, we like to have rules in place. How much we allocate to a certain strategy or asset class, when we reallocate and rebalance, and what system we use for determining if a trade is necessary are all important rules we can put in place to avoid making emotional or reactive changes. However, if something isn’t working for a while, it can be tempting to change the rules. It can be very tempting after seeing a particular asset class lose value for months or even several years to create the rule that we no longer use that asset class. A lot of people created this rule back in 2008 in regards to equity investing in general and then proceeded to miss out on what may be the largest market rally that they will see in their lifetime.

Reactive rule-making can also place an unnecessary burden on other areas of your financial life. Often a bad experience after making a purchase will guide us in future purchases and lead us astray. If you bought an imported budget-conscious vehicle and are unsatisfied with it, you might create several largely arbitrary rules to follow for subsequent purchases: don’t buy foreign, don’t buy base models, don’t buy green cars, etc. But that rule may guide you toward spending money unnecessarily on your next car, and the car after that, and it might permeate into your other purchases and cause you to spend more money in areas you don’t need to. Before you know it, you’ve wasted thousands of dollars and are no further ahead or more satisfied, and at some point you will have a similar experience with another product, this time an expensive one, and where do you go from there?

Sometimes we just need to accept that we will make mistakes, we will be the victim of a defective or poorly constructed product, and we will endure many ups and downs in the market, but rather than making a rule the first time one of these happens, we should try to learn as much as we can from it. Understanding the long-term historic performance of an asset class or the market in general will give us a better idea how much volatility to expect (and don’t forget, there can always be more!), and reviewing a potential purchase as thoroughly as possible beforehand is a good way to avoid dissatisfaction, but at the end of the day we have to admit to ourselves that sometimes these things just happen.
Of course, if you find them happening more often than not, then it might be time to admit that you need a rule.