Why It's Better to Lose Money Fast

Credit.com

Most new things fail. Four of five new restaurants close within five years. Three quarters of venture capital-backed startups don’t return their money to investors. Most books don’t earn back the author’s advance. Failure is so common that Google executive Albert Savoia created a rule of thumb for it, called the “Law of Failure.” No one sets out to fail, and often, it’s no one’s fault. It’s the idea’s fault. Among Savoia’s many pithy sayings: “Make Sure you are building The Right ‘It,’ before you build ‘It’ right.

Failures stink. But they are also expensive. They cost a lot of money, and more important, they cost a lot of time and emotional angst. All that time you spend giving CPR to an idea, a story or a relationship that’s dying could be better spent on doing something else. It sounds funny, but if you want to get better at anything, before you think about success, you need to get better at failing. And failing big. If failure is in your future, you might as well be good at that. You want to flame out spectacularly at whatever it is. Most of all, you want to avoid failing slowly.

Slow failure means throwing good money after bad. Slow failure means spending your entire 20s doing something that holds no future for you. Failing slowly means spending the very last bit of your savings (and probably your credit) on a business idea that’s doomed, rather than saving those precious last dollars for the next thing.

The biggest mistake people who file bankruptcy make is spending every last dollar they have paying off noisy debt collectors, such as credit card firms. Some even take out second mortgages or raid retirement accounts to do this. Generally, home and retirement wealth can be protected in bankruptcies, and credit card debt can be discharged, meaning those final desperate payments were a waste of money, the loss of the last little bit of a cash a struggling family could have used to reboot their lives.

How to Fail Faster

Failing slowly is the only real failure. Being stuck in a slow, downward spiral is the worst kind of stuck there is. Our culture is afraid of failure, and that’s part of the problem. We do anything we can to avoid admitting failure, when what we should really do is embrace it.

Embrace failure? How? Savoia offers one method: The prototype.

You’ve heard of prototypes. They’re an important part of the development process, used to show investors or others how a product might work without having to manufacture on a large scale. Prototypes, however, are generally fully operational. That means they can still take years to build. Savoia prefers what he calls the “pretotype.” A pretotype could be as simple as a drawing of a website that you imagine is fully functional, which you allow others to “test.” Among the first pretotypes – the first Palm Pilot, the precursor to tablet computers, was initially a wooden board with buttons painted on it that people carried around and pretended to use so they could test what its core functions could be.

The advantage is enormous: While a test website might takes weeks to build, a pretotype can be drawn in MS Paint within a few minutes. With pretotyping, you never have to say, “Sorry, it’s not worth experimenting with that idea,” because there are hardly any barriers to entry.

Pretotypes are liberating. With a little creativity, you can create your own “startup” in a day or two, run it through some paces, and fail within a week! But do that for a year, and you have gone through 50 “rev” cycles. Even with a spectacularly high failure rate, you are bound to hit on a success along the way. But remember, pretotypes only work for those who are open to failure.

Failing With Your Money

The concept of failing fast, and the prototype, apply even if you aren’t a budding inventor. Here’s how these relate directly to the world of personal finance:

Good Money After Bad

An example of this classic situation is paying to put a new transmission or engine in that old car. It’s often hard to let go of old Betsy, but it’s rarely wise to spend more than $1,000 repairing a car that’s 10 years old. Let it fail and put the money into a reasonable auto payment for an inexpensive new car instead. On a related note, many folks pay for collision and comprehensive insurance on their old clunkers long after it makes sense. Remember, you only get the value of the car, minus the deductible, after an accident or theft. If your car is only worth $3,000, it doesn’t make much sense paying $400 a year for collision and comprehensive. One rule of thumb: When the annual premium exceeds 10% of the car’s value, drop it.

Bankruptcy

Covered above, but worth repeating. When I talk to bankruptcy attorneys, every one says the same thing: People always wait too late to see an attorney, and foolishly spend their last few dollars. When it’s time, it’s time.

Just make sure you understand that bankruptcy will do major damage to your credit score, though it will recover over time. You can see where your credit currently stands, and what you could do to improve it, for free on Credit.com.

Stocks

We’ve all been there. “I bought this at 30, it dropped to 20, and I’m not selling it until it goes back up to 30!” Well, that’s dumb. The stock sits at 20 for a reason. It’s just as likely you will lose even more by holding on. Sell. Cut your losses. Fail as fast as you can! You can apply this line of thinking to any investment, of course. When you are losing money, holding out hope is a bad strategy. By the way, the investing version of the prototype is the model portfolio. Many investing sites let you set up a “fake” investment account so you can see how you would do without playing with real money. That’s a great way to dip your toe in the game without risking years or earning power.

Homes

A similar rule applies. Refusing to sell your home because you have established a mythical value in your head (We paid $600,000, we have to get $600,000!) is a doomed strategy. It’s sometimes called emotional pricing. In a similar vein, some people decide they have to hold out at least until the purchase price net covers their outstanding mortgage. While that’s nice, the market doesn’t care what your mortgage is. The price is the amount someone else is willing to pay. It has nothing to do with how much you owe. You might some day get a higher offer, but if you have to pay six more months of property tax while waiting, is that really a good idea? Cut your losses, fail, and move on.


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