5 Financial Decisions That Sound Smart but Are Really Dumb

Norma Yaeger, 83, of Encino, Calif., thought she was making a smart financial decision last fall, when, after pulling into a Ralph's supermarket, she impulsively hired two men to fix her car.

"Two nice gentlemen came over to me and look at my fender, which was badly scratched. They said that they had a compound that will remove the scratches and restore the paint," Yaeger says.

They would fix it, for just $50.

Yaeger isn't a rube -- she was, in fact, the first female stockbroker to work at the New York Stock Exchange (and recently wrote an autobiography, "Breaking Down the Walls"). She also served as president of two stock brokerage firms. The men who approached her seemed honest, and Yaeger was self-conscious about her fender. She paid the $50, a snap decision that seemed perfectly reasonable.

Instead -- and you knew this was coming -- when she returned from grocery shopping, her car fender hadn't improved. In fact, it looked far worse. Yaeger drove to a mechanic and was told that it would take several days and $1,000 to fix her car."The worst part was that I had to tell my husband about this embarrassing story," Yaeger says.

Most people have made a financial mistake that seemed sensible at the time, but in hindsight turned out to be pretty stupid. With that in mind, here are some thoughts from a slew of personal finance experts on five financial decisions that sound smart but are likely a waste of money.

The Mistake: Buying something because it is interest-free for awhile.

Why It Can Seem Smart. It's tempting to buy something with a zero-interest window, such as a "90-day, same-as-cash" offer, in which you're charged no interest if you pay for the product within 90 days.

Why It May Be Stupid. Many people don't end up saving the money or putting it aside when they get it, "and they end up paying accumulated interest at a high rate plus compounding interest on the balance going forward," says Kelley Long, a Chicago-based certified public accountant.

She says consumers make such mistakes when they open a store credit card to get a 15 percent discount, for example, but then carry a 22 percent balance. Paying for things with a rewards credit card to earn frequent flier miles can also be a mistake if you're not paying off the card in full each month. "The interest expenses end up far outweighing the price of an airline ticket," Long says.

The Mistake: Buying long-term care insurance when you're broke.

Why It Can Seem Smart. Who wouldn't want long-term care insurance? It helps pay for basic activities that people need to do on a daily basis, like getting dressed, bathing and preparing food.

Why It May Be Stupid. Senior citizens who are worried about their long-term prospects but don't have money to spare buy it but shouldn't, says Sonja Kobrin, a geriatric care manager in Palm Beach, Fla., and owner of V.I.P. Care Management. Kobrin says many seniors buy it when "their economic status is so low that they would qualify for Medicaid programs, which would pay for care and facility costs at no charge to them."

The mistake: Buying life insurance for a child.

Why It Can Seem Smart. If you bought it, you were probably convinced by an aggressive insurance salesperson that you need insurance for burial purposes, in case the worst happens. Or you may have bought it just to be on the safe side -- no matter what, your child will have life insurance.

Why It May Be Stupid. Your reasoning may be correct, but generally, parents take out life insurance because their child depends on them for financial support. "Unless your kid is Justin Bieber, it is probably unlikely that you need to consider taking out a life insurance policy for him," says Marvin Feldman, CEO of the LIFE Foundation, a nonprofit that educates the public about life insurance. Feldman adds that if there is a history of significant health problems in your family, you may want to consider life insurance so your child doesn't have trouble getting it as an adult. But all in all, you're probably better off putting that money into your child's college account.

The mistake: Not having a credit card.

Why It Can Seem Smart. If you've ever had mountains of credit card debt, it seems like the smartest decision in the world. Who wants to be beholden to a credit card company?

Why It May Be Stupid. "Many people believe they are helping themselves by not having a credit card at all when, in fact, you can be hurting your credit score," says Priya Haji, CEO and co-founder of SaveUp, a free rewards program that helps people save and get out of debt.

Haji is correct -- at least to a point. If you cannot trust yourself with a credit card, you're probably better off without one. 

But like it or not, lenders consider whether you have a credit card when deciding whether to offer you credit. If you want a home or a car someday, and you don't have enough money saved to buy either outright, showing that you can peacefully coexist with your credit card may mean you'll get a much better loan than if you don't have a credit card.

If you're really credit-card averse, Haji suggests getting one with no annual fees and making purchases semi-regularly -- then paying them off within the month.

The mistake: Not allotting space in your weekly or monthly budget for fun.

Why It Can Seem Smart. You're budgeting, which is serious work. It seems much wiser to budget for things you know you need, like food and rent, than something you don't, like going to the movies.

Why It Is Stupid. "Just as it's important for people trying to lose weight to allow themselves some 'treats,' it's important for those on a budget to be realistic and include some allocation for fun," says Kevin Gallegos, vice president of Phoenix operations for Freedom Financial Network, a national company that aims to help consumers get out of deep debt. "Depending on income, it might be something as simple as a new bike helmet to enjoy more cycling time, or a small amount for a dinner out each month."

In other words, you're only human. You'll likely do something financially unnecessary or impulsive every month, whether you plan to or not. If you're shrewd, you'll plan for that in your budget, too.

By Geoff Williams

Read More

Guide to buying back shares

Managers, like investors, often gauge the performance of share repurchases against that old investment adage: buy low, sell high. If they could consistently time repurchases to periods when shares were undervalued, as some try to do, they could reward loyal shareholders at the expense of those who sell out.

Of course managers, like investors, can’t always do what old adages suggest. Markets are volatile and unpredictable, and what seem to be longer-term trends can quickly reverse course. Overconfidence can lead executives to buy back shares even at the peak share price—and a bias for caution can restrain them from buying shares when prices are lowest. The result is that companies seldom consistently pick the right time to buy back their shares at advantageous prices.¹Indeed, for the years 2004 through 2010, our analysis finds that a majority of companies repurchased shares when they and the market were both doing well—and were reluctant to repurchase shares when prices were low relative to their intrinsic valuations. Few stopped repurchases even as the market peaked in 2007. And when the market bottomed in 2009, few companies were buying back shares.

One global technology company is a typical case. After a large repurchase of shares in 2004, the company accelerated its purchases as profits and share prices increased. Just as prices peaked, in 2007, it bought back the most shares ever—more than five times as much as it had in 2004. As the financial crisis developed in 2008, managers reduced the level of the company’s repurchases. It didn’t buy back any shares in 2009 or 2010, despite continued strong profits and a bargain on share prices, which had dropped by around 50 percent. In hindsight, it’s easy to understand why the company stopped the buybacks in 2009 and 2010, amid deep market uncertainty. Nonetheless, the best time to buy is generally when everyone is scared.

That buyback pattern is not unique. We looked at the S&P 500 companies between 2004 and 2011, a period for which we have quarterly share buyback data. It turns out that companies don’t just tend to buy back more shares when the underlying earnings are strong—they also seem more willing to do so when their share prices are high. The result is a cyclical pattern: companies pay out disproportionately large amounts at the top of a cycle and withhold repurchases at the bottom.

Over longer-term periods, such as the up-and-down market cycle from 1998 to 2005 or 2006 to 2010, share repurchases came at the expense of long-term loyal shareholders by delivering lower returns than they might otherwise have received. We compared the actual repurchases of S&P 500 companies from 2004 to 2010 with a modeled strategy of buying the same dollar amount of shares each quarter, much as an investor might regularly purchase shares as part of an income-averaging approach or as a company might think of a share repurchase as akin to a regular dividend. We found that the latter strategy significantly outperformed what actually happened. For companies that repurchased 5 to 25 percent of their outstanding shares, the median return of actual buybacks lagged behind that of the modeled strategy by 4.5 percent. For companies that bought back more than 25 percent of their shares, the median return of actual buybacks lags behind that of the alternative approach by 3 percent. Only 31 percent of the companies earned a positive return from buying back shares—less than you would expect from a random throw of the dice.

These findings suggest an easy fix: companies should give up trying to time the market. Long-term shareholders will be better off if management would simply forecast total excess cash and evenly distribute it each calendar quarter as “dividends” in the form of share repurchases. CFOs can approach such regular buybacks in two ways. First, they can repurchase shares as excess cash becomes available. This is the easiest approach and the one least likely to send adverse signals to investors around the potential for excess cash or cash shortfalls. It is probably right for most companies, even if it generates lower returns.

Second, companies can evenly distribute similarly sized repurchases over time. For those willing to stand by their forecasts of future cash flows, this dividend-like approach will probably generate higher returns for shareholders. Investors will, however, inevitably try to determine exactly what management is thinking, given the level of repurchases it sets. And it’s worth bearing in mind that as with dividends, investors may react negatively if repurchases eventually decline, viewing this as a signal of management’s pessimism.

Read More