There are many ways to destroy our wealth. Pay high investment costs. Day trading stocks. Buy timeshare. Marry a donor. Buy variable annuities. Retiring too early. Buy leveraged exchange traded funds. Imitate the spending of our rich friends. The list goes on and on.
But anyone can slowly ruin themselves – and a lot of people do. What really gets attention is when it goes fast. Do you want to blow up your financial life? Here are nine ways to ruin yourself in a rush:
1. Sell stocks briefly. If you buy a single stock or bond, the most you can lose is your original investment. That would be awkward, but nowhere near as awkward as your entire portfolio imploding.
That brings us to short selling. We were reminded earlier this year of the dangers, compliments of GameStop and the hedge funds betting on the decline. These hedge funds had borrowed GameStop stock and then sold it in hopes of buying back the stock at much lower prices. Instead, GameStop's shares rose and the hedge funds, which had potentially unlimited losses, had to buy back the stock at far higher prices.
Because of these potentially unlimited losses, short selling is one of the most dangerous games on Wall Street. Many people like to "play" with part of their portfolio in the market. If you do, don't sell stocks, for God's sake, because a seemingly small bet could cost you far more than you ever imagined.
2. Invest heavily in your employer's stocks. If you think your employer's stock is a solid investment, think about the poor people who work at PG&E. What could be safer than a utility company, the epitome of the widow and orphan population? Your stocks have lost 80% of their value in the past five years.
What if you work for a high-flying tech company? Surely you want to invest heavily in its stocks? A decade ago I was at a business lunch in Los Gatos, California. Sitting next to me was a former employee of JDS Uniphase, one of the hottest stocks of the 1990s, and lost almost all of its value when the tech bubble burst. My dinner companion shared how employees were given a special number to call when they wanted to cash out their stock options, which – to him – were worth more than $ 1 million at one point. "I just had to pick up the phone," he complained. He never called.
My advice: limit a single stock to no more than 5% of the value of your stock portfolio – and this is especially true if it's your employer's stock. Remember, your employer is the most dangerous stock you can own as you may be both unemployed and hold a handful of worthless stocks.
3. Do not take out disability insurance. Our most valuable capital is our human capital, our earning capacity. What if we cannot work due to illness or accident? If we have enough time to retire, it may not matter, at least financially. It may also not matter whether our employer has good disability insurance.
But if our employer doesn't – or if we are self-employed – we could get into great financial trouble. Yes, social security offers disability benefits. But despite the stories of perfectly healthy people receiving social security benefits for the disabled, the reality is that qualifying is terribly difficult. You must have a disease that is serious enough to cause death or prevent you from working for 12 months. In addition, the benefits are not particularly generous. The result: if you don't have insurance coverage and your nest egg isn't big, disability insurance is vital.
4. Invest in the margin. If you want to short a stock, you'll need to open a margin account that you can use to borrow against the value of your portfolio. You can also use a margin account to buy long stocks. This increases your exposure to the stock markets by using borrowed money to buy additional stocks. Such a margin bond can increase your returns when the stock market rises.
But what if stocks fall instead? They could be wiped out or near it. Say you have $ 50,000 worth of stocks and then borrow additional $ 50,000 worth of margins, which doubles your exposure to the stock markets to $ 100,000. If the market falls 29%, not only will you lose nearly $ 30,000, but you may get a margin call because your borrowing – as a percentage of the value of your account – is now too high. If you have no cash or securities in the account, you could be forced to sell some of your holdings, which will freeze your losses.
Still, I'm not entirely against margin accounts. They can be a useful substitute resource for emergency funds, allowing people to resolve short-term financial problems without disrupting their portfolios and potentially triggering capital gains taxes. However, borrowing should only be short-term and represent a modest percentage of a portfolio.
5. Get a divorce. My greatest happiness comes from those around me. But also my biggest bills – some of which I wasn't expecting. Do you want to avoid big financial problems? Think long and hard before you get married, because not getting married can cost you half of everything. I've been divorced twice and both periods are some of the worst times of my life.
Unfortunately, there are other ways that family can cost you dearly. Are you thinking of lending money to the family or signing their loans? I loaned my daughter money and everything went smoothly, but I'm starting to think that this is unusual because I've heard so many horror stories.
Another tip: talk to your parents about their retirement plans, including how to deal with long-term care costs. When our parents – or our adult children – find themselves in financial straits, it is terribly difficult to say "no". At this point, their problems are ours. Did I mention that a private room in a nursing home is now nearly $ 106,000 a year?
6. Sell bare calling options. Many conservative investors like to write so-called covered calls. This involves selling call options against the stocks they own, generating additional income in the form of a call premium. The disadvantage: If the shares concerned rise above the "exercise price", they are "called up" by the buyers of the call options. This means that the option sellers miss out on profits beyond the strike price. I'm not a fan of covered calls, but it's a conservative strategy indeed.
Now imagine a slightly different scenario: what if we write call options – but don't own the underlying stocks? Suddenly the strategy goes from conservative to extremely dangerous. Indeed, selling uncovered calls is equivalent to selling a stock, and as with short selling, if the stocks involved shoot higher, the potential loss is enormous.
7. Don't bother about health insurance. Many people view health insurance as a way to pay for their annual physical or occasional prescription. But from my point of view, these are only fringe benefits. So why get health insurance? The two main benefits are the insurance company-negotiated discounts on medical expenses and the policy's maximum annual expense limit, which limits your financial problems. Without these two benefits, there is a great risk of high medical costs taking you to bankruptcy court.
8. Sell put options. As with selling call options, selling put options allows you to generate additional income in the form of option premiums. However, this income is modest compared to the risk involved. When you sell a put option, you agree to buy the underlying stock at the strike price for the life of the options contract. If the underlying stocks stay at or above the strike price, this is not a problem. But if the stock falls, you could be in big trouble.
Of course, the potential loss is not as great as with a naked call option, as a stock can only lose 100% of its value while its potential gain is unlimited. However, this loss could be devastating unless the potential success of the put option is small compared to the size of your overall portfolio.
9. Skip the roof liability insurance. It's hard to know how likely we are to be sued. Statistics are hard to come by because many lawsuits are tacitly resolved and not challenged in court. Still, given the potentially crippling cost, you want to protect yourself.
Your homeowner's home and auto insurance includes some liability coverage, but it may be capped at, say, $ 300,000. For further protection, consider adding an umbrella policy. You might be able to get a $ 1 million policy for just a few hundred dollars a year. In addition to this financial protection, umbrella insurance should ensure that the insurance company's lawyers go to bat on your behalf in the unfortunate event that you are sued.
This column originally appeared on Humble Dollar. It was republished with permission.
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