Nine Roads to Ruin

Jonathan Clements

THERE ARE MANY WAYS to fritter away our wealth. Pay high investment costs. Day trade stocks. Buy timeshares. Marry a spender. Purchase variable annuities. Retire too early. Buy leveraged exchange-traded funds. Mimic the spending of our wealthy friends. The list goes on and on.

But anybody can ruin themselves slowly—and plenty of people do. What’s really attention grabbing is when it happens quickly. Want to blow up your financial life? Here are nine ways to ruin yourself in a hurry:

1. Sell stocks short. If you buy an individual stock or bond, the most you can lose is your original investment. That would be unpleasant, but not nearly as unpleasant as seeing your entire portfolio implode.

That brings us to short-selling. We were reminded earlier this year of its dangers, compliments of GameStop and the hedge funds that bet on its share price decline. Those hedge funds had borrowed GameStop stock and then sold it, hoping to buy back the shares at much lower prices. Instead, GameStop’s shares soared and the hedge funds—facing potentially unlimited losses—were forced to buy back the stock at far higher prices.

Because of those potentially unlimited losses, short-selling is one of the most dangerous games on Wall Street. Lots of folks like to “play” the market with a sliver of their portfolio. If you do that, for goodness’ sake, don’t sell stocks short, because an apparently small bet could cost you far more than you ever imagined.

2. Invest heavily in your employer’s stock. If you think your employer’s shares are a solid investment, ponder the poor folks who work at PG&E. What could be safer than a utility, the quintessential widows-and-orphans stock? Its shares have shed 80% of their value over the past five years.

What if you work for a highflying technology company? Surely you’d want to invest heavily in its shares? A decade ago, I was in Los Gatos, California, at a business dinner. Sitting next to me was a former employee of JDS Uniphase, which had been one of the hottest stocks of the 1990s, only to lose almost all its value when the tech bubble burst. My dinner companion recounted how employees were given a special number to call if they wanted to cash out their stock options, which—for him—were at one point worth more than $1 million. “All I had to do was pick up the phone,” he lamented. He never made the call.

My advice: Limit any one individual stock to no more than 5% of your stock portfolio’s value—and that’s especially true if it’s your employer’s shares. Remember, your employer is the most dangerous stock you can own, because you could potentially end up both out of work and holding a fistful of worthless shares.

3. Forgo disability insurance. Our most valuable asset is our human capital, our income-earning ability. What if we can’t work because of illness or an accident? If we have enough set aside to retire, it may not matter, at least financially. It may also not matter if our employer offers good disability coverage.

But if our employer doesn’t—or if we’re self-employed—we could be in deep financial trouble. Yes, Social Security offers disability benefits. But despite stories of perfectly healthy people receiving Social Security disability benefits, the reality is that qualifying is awfully tough. You need to have a condition that’s sufficiently severe that it could cause death or prevent you from working for 12 months, plus benefits aren’t especially generous. The upshot: If you don’t have coverage and your nest egg isn’t large, disability insurance is crucial.

4. Invest on margin. If you want to short a stock, you need to open a margin account, which allows you to borrow against your portfolio’s value. You can also use a margin account to “go long” stocks—increasing your stock market exposure by using borrowed money to purchase additional shares. Such margin borrowing can super-charge your returns when the stock market is climbing.

But what if stocks go down instead? You could get wiped out, or close to it. Suppose you have $50,000 in stocks and then borrow another $50,000 on margin, thus doubling your stock market exposure to $100,000. If the market tumbles 29%, you’d not only lose almost $30,000, but also you could get a margin call because your borrowing—as a percent of your account’s value—is now too high. If you don’t have cash or securities to add to the account, you could be forced to sell part of your holdings, thus locking in your losses.

That said, I’m not completely against margin accounts. They can be a useful backup source of emergency money that allow folks to deal with short-term financial problems without disrupting their portfolio and potentially triggering capital gains taxes. But the borrowing should only be short term and only represent a modest percentage of a portfolio.

5. Get divorced. My greatest happiness comes from those who surround me. But so, too, have my biggest bills—a few of which I didn’t expect. Want to avoid large financial hits? Think long and hard before you marry, because unmarrying could cost you half of everything. I’ve twice been divorced and both periods rank among the worst times in my life.

There are, alas, other ways that family can cost you dearly. Thinking of lending money to family or cosigning their loans? I’ve lent money to my daughter and everything’s gone smoothly, but I’m starting to think that’s unusual, because I’ve heard so many horror stories.

Another tip: Talk to your parents about their retirement finances, including how they’d cope with long-term-care costs. If our parents—or our adult children—find themselves in dire financial straits, it’s awfully hard to say “no,” at which point their problems are ours. Did I mention that a private room in a nursing home now costs almost $106,000 a year?

6. Sell naked call options. Many conservative investors like to write so-called covered calls. This involves selling call options against the stocks they own, which earns them extra income in the form of a call premium. The downside: If the stocks involved rise above the “strike price,” they’ll get “called away” by the buyers of the call options. That means the option sellers miss out on the gains over and above the strike price. I’m not a fan of writing covered calls, but it is indeed a conservative strategy.

Now, consider a slightly different scenario: What if we write call options—but we don’t own the underlying stock? Suddenly, the strategy goes from conservative to hugely dangerous. Indeed, selling uncovered calls is the equivalent of selling a stock short and, as with shorting, the potential loss is huge if the shares involved shoot higher.

7. Don’t bother with health insurance. Many folks view health insurance as a way to pay for their annual physical or the occasional prescription. But, as I see it, those are just fringe benefits. So why buy health insurance? The two key benefits are the medical-cost discounts negotiated by the insurance company—and the policy’s annual out-of-pocket maximum, which puts a cap on your financial pain. Without those two benefits, there’s a grave risk that major medical costs could land you in bankruptcy court.

8. Sell put options. As with selling call options, you can earn extra income—in the form of option premiums—by selling put options. But that income is modest compared to the risk involved. When you sell a put option, you commit to buying the underlying stock at the strike price during the life of the option’s contract. If the underlying shares stay at or above the strike price, that isn’t a problem. But if the stock plunges, you could be in deep trouble.

To be sure, the potential loss isn’t as great as with a naked call option, because a stock can only lose 100% of its value, while its potential gain is unlimited. Still, that loss could be devastating, unless the potential hit on the put option is small compared to your total portfolio’s size.

9. Skip umbrella liability insurance. It’s hard to know how likely we are to get sued. Statistics are hard to come by because many lawsuits are quietly settled, rather than contested in court. Still, given the potentially crippling cost, you want to protect yourself.

Your homeowner’s and auto insurance will include some liability coverage, but it might be capped at, say, $300,000. For further protection, consider adding an umbrella policy. You might be able to purchase a $1 million policy for just a few hundred dollars a year. In addition to that financial protection, an umbrella policy should ensure that the insurance company’s lawyers go to bat on your behalf, should you have the misfortune to be sued.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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