Why Fear, Greed Block Successful Financial Planning

Financial adviser Carl Richards gave himself bad advice. During the housing boom, Richards bought a place in Las Vegas with no down payment. He then borrowed more money against his home, and when the economy tanked, he was forced to sell the house for less than the original loan. Richards talks to Linda Wertheimer about an article he wrote for The New York Times, which led to his new book The Behavior Gap.

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LINDA WERTHEIMER, HOST:

A new year means new predictions for the stock market. Carl Richards says, don't get wrapped up in them. Some people may know Carl Richards as the financial adviser who gave himself bad financial advice. During the housing boom, he fell for a place in Las Vegas and bought it with no downpayment. When the economy tanked, he was forced to sell that house for less than the original loan.

Richards wrote about this humiliating experience for the New York Times. He also blogs about personal finance for the Times. And now he has a new book, called "The Behavior Gap." He spoke to us from member station KPCW in Park City, Utah. I asked him if losing his home has changed the advice he gives.

CARL RICHARDS: No question. I mean, going through what I went through certainly informed the advice that I give, and the stuff I write about - for sure.

WERTHEIMER: Among other things, you write that financial decisions should be based on principles and not on feelings, but that feelings often get in the way of good decisions. What feelings are you talking about?

RICHARDS: You know, the two primary culprits - it often seems - that are always sort of lurking around bad financial decisions, are fear and greed.

WERTHEIMER: Like if the price of houses is rising fast, greed takes over and cancels your sort of common-sense feeling that this is crazy.

RICHARDS: Yeah. It applies to a lot more than just housing. But in that specific example, of course, it was really - I mean, if you take yourself back to that time - and specifically, if you take yourself to some place like Phoenix or Las Vegas - and everything around you is reinforcing the idea that housing prices are going to continue to go up, that your income is going to continue to grow, it's very easy to start believing that.

And then you start making decisions that in hindsight are very obvious, and even at the time might have been obvious to an outside observer. But we just get so close to those decision ourselves, it's hard to be objective.

WERTHEIMER: And you write that what we ought to be doing is thinking of principles. Now, what sorts of principles should we think about when we're making financial decisions?

RICHARDS: Well, things don't continue to go up forever - that's a principle. Diversification - you don't put all of your eggs in one basket. Leverage is a double-edged sword and can be incredibly painful when you're on the other side of it.

WERTHEIMER: Maybe you should explain leverage.

RICHARDS: Leverage is just borrowing money. When you put 20 percent down on your house, you're certainly leveraged. When you put 5 percent down, you are more leveraged.

WERTHEIMER: Now, you also write that the people we love, and our most important relationships, should be a baseline for making all kinds of financial decisions. Now, what do you mean by that?

RICHARDS: You know the old saying that the calendar and the checkbook never lie? It just means if I really want to understand what you really value, it doesn't matter so much what you say you value. We can look real quick and see how you're spending your time, and how you're spending your money.

WERTHEIMER: So then you sit down with that person; you say now, wait a minute. Let me explain to you that you're telling me one thing, but I'm looking at another thing.

RICHARDS: That's the essence - to me, at least - of good financial advice. And we hired a financial planner, and what he does for us is really reminds me of the things we told him were important.

WERTHEIMER: Now, you do say that you think financial plans are pretty much worthless.

RICHARDS: Right.

WERTHEIMER: What do you mean? Why? I mean, that's the business you're in.

RICHARDS: A financial plan has almost become a product, right. You go in, you meet with somebody; you leave with a 2-inch thick binder. Those plans are full of guesses. We have no idea what interest rates are going to be next week, let alone 20 years from now. We have no idea what return you're going to get. We have no idea how long you're going live.

Understanding that we have two choices, right. We can say well, the whole thing is a guess; forget it. Or, we can start to incorporate in our lives sort of a process of saying, all right, let's make the best guess we can. Let's let go of the need for precision. And then the very important part, Linda, is to revisit those guesses.

WERTHEIMER: How do you feel about what happened to you, looking back?

RICHARDS: I still have mixed emotions about it, obviously. I mean, we made some mistakes, and it's been painful to continue to talk about it. My goal was to try to be as honest as I could, despite knowing that we all self-deceive ourselves. I mean, you know.

(SOUNDBITE OF LAUGHTER)

RICHARDS: And hope that those lessons would be sort of burned in my psyche to prevent making the same mistakes again.

WERTHEIMER: Mr. Richards, thank you very much.

RICHARDS: Thank you. It's a pleasure.

WERTHEIMER: Carl Richards is a certified financial planner working in Park City, Utah. He's the author of "The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money."

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