Pre-Recession Thinking Could Put You in Financial Peril

I don't need an official government pronouncement to tell me that we're in a recession. Based on what I am hearing these days, I have all the evidence I need to know we're experiencing a serious downturn.

Past Masters
The most repeated phrase I'm hearing these days is "used to be." As in, "My investment used to be worth $20,000 and now it's worth $15,000, so I'm just waiting for it to get back to $20,000 before I sell." Or, "We want to sell our house, but our agent says its market value today is $250,000, but we know last year it used to be worth $300,000." Or, "I was laid off four months ago and the only job I have been offered has a salary that's 15 percent below what my pay used to be."

Folks, what used to be is useless. I know it's hard to change your outlook and adjust to reality, but the former value of an investment, a home, or even your salary from the job you were just downsized out of doesn't really matter today.

When so many people are fixated on the past, I know we've got ourselves some serious economic problems. To survive today requires dealing with what's happening today, not what you remember from yesterday.

Anchor or Albatross?
Focusing on what used to be is part of a classic behavioral trait known as anchoring. We throw down an anchor at a reference point that's known to us -- the purchase price of a stock, say -- and won't budge one inch from that anchor point when evaluating its value.

What can happen is that someone who's bought a stock at $50 a share will decide that when that the stock trades at $40 a share they're going to hang on just until it gets back to $50. They're anchored on that price, and instead of looking at the fundamentals for that company they're absurdly basing their investment strategy on an arbitrary number.

Well, a stock has no idea what you personally paid for it. I know that sounds ridiculous, but it's basically what you're assuming if you find yourself holding onto an investment simply because you want to break even. Do you really think the stock knows what your break-even point is? If the investment no longer makes sense on the fundamentals, get out and put your money to work in an investment that does make sense.

Upside Anguish
The same flawed anchoring can even get you in trouble on the upside. Say you bought a stock and had it in your head that you would sell at a 20 percent profit. Everything is going great and you have an 18 percent gain when you start to see some deterioration in the fundamentals.
Instead of following the numbers you follow your artificial goal of netting 20 percent, so you don't sell. Three months later you're still waiting for the stock to reach your artificial 20 percent threshold, only it's fallen back to just a 5 percent gain. You could've taken your profits off the table when you had a good idea there was trouble ahead, but instead you got dragged down by your anchor.

Real Estate Reality
If you seriously want to sell your house right now, you need to get rid of your anchor mentality. The fact that you know the house next door sold two years ago for $150,000 more than your agent says you can get for your house today is irrelevant. The fact that Zillow.com indicates that your house was worth $80,000 more a year ago is beside the point -- you didn't put your house on the market two years ago, or a year ago. You're putting it on the market today.

Pricing correctly is the surest way to squeeze the most out of the sale. If you insist on overpricing, I promise you the house isn't going to sell. You can anchor all you want, but no buyer is going to pay you a price based on where the market was a year or two years ago. And while your house is languishing on the market, you're going to be stuck with the carrying costs.
Let's say your mortgage, tax, and insurance run you $4,000 a month: After four months of your house not selling, you're out $16,000 and you drop the price down to a competitive market price and the house sells. If you'd just done that when you first listed the house, you would've saved yourself $16,000 in carrying costs. That's one expensive anchor.

Competent Compensation Rules
If you find yourself out of work in this tough economy, it is vitally important to set a realistic price (salary) goal before you start your search. That means gathering market data on what the job you're interviewing for pays in today's open market. What you earned at your last job is a useless anchor -- that was a different company and a different job.

In fact, if you've been with one company for a long time, you may have been highly compensated for all the internal knowledge you had about how that particular company ran. You had great company-specific value. Maybe some of that value is transferable to your next job, but maybe it isn't. You need to be open to the idea that all the value you had at your old job isn't necessarily going to be what prospective new employers need or want.

Ideally, you should always fall forward into a higher-paying job. But if you've been downsized and need to get back to work pronto, let go of your salary anchor and focus on what the going rate is for a job you can get hired for today.