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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.

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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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johny
johny
7 months ago

Jonathan,

have you married a third time? If yes, what have you done to make sure another painful event won’t happen?

As far as thinking long and hard before marrying, how does one successfully do that? What can we do to ensure marriage to a particular person is the right course of action?

Yes, Warren Buffet also did say marrying the right person is the most important decision, but even he didn’t say how to do it.

How is this for young people?

1. Is the person attractive to you ? Yes/No If no, then stop

2. Doe the person have STEM or Ivy degree? Yes/No If no, then stop

4. Are the person’s parents divorced? Yes/No If yes, then stop

5. Do person’s friends think person is warm & kindhearted? Yes/No If No, then stop

6. Do person’s values pertaining to spending, lifestyle and priorities align? Yes/No if No, then stop.

7. Will person agree to a prenup? Yes/No If no, then stop

Jonathan Clements
Jonathan Clements
7 months ago
Reply to  johny

No, I haven’t married for a third time — and, when I divorced the second time, the cost was small relative to my net worth. I don’t have a surefire strategy for ensuring a marriage works out. I wish I did. But living together first and for a healthy amount of time strikes me as a good first step.

medhat
medhat
7 months ago

Thanks for another great read Jon. I must admit, “options” tend to give me palpitations, so I guess that’s simply a natural defense strategy. And I agree with your other points. Looking at the horizon of my own neighborhood, however, what I see often is people playing “catch up” with retirement finances, having stayed just a bit too long at the tempting watering hole of flashy material items and experiences. Then once they start sobering up are faced with an urge to catch up quickly, taking on risk (such as options and shorts) in an attempt to make up for lost time. While I understand the sentiment, I also understand that with risk comes… risk, risk that doubling-down leads to further losses.

Joey
Joey
7 months ago

I don’t have homeowners insurance or auto insurance because I don’t own a home or auto. Should I still get an umbrella policy? If so, how can I find an insurance company to sell me one alone?

Jonathan Clements
Jonathan Clements
7 months ago
Reply to  Joey

The insurer may require you to have modified, low-cost versions of both policies. I don’t currently own a car and so, to purchase umbrella insurance, I had to get a non-owner’s auto policy. It isn’t very expensive.

Ormode
Ormode
7 months ago

Selling puts to buy a stock is actually a reasonable strategy. If you want to own a company, but you think the price is too high, you can sell puts for the number of shares you want to buy at the price you want to pay. This is assuming you have the cash and you are ready to buy the company even if there are unfavourable developments. If the company is a good one, you may have to go through several rounds of selling puts, having them expire, and not getting any stock. Just be disciplined and don’t increase the strike price which you are willing pay to the the company.

alain
alain
7 months ago
Reply to  Ormode

Indeed. 100% correct. I use it to enter into stocks that I anyway would like to own. Making some money while waiting for a good entry point. Open positions never more than 2% of my investing stock portfolio, so that I can survive it if the stock crashes, the put option contract gets activated, and I have a stock in my portfolio that went down farther that I ever would have thought. If that happens, I have positioned myself to be able to then double down to a position that is now 4% of my overall portfolio, to recoup the “loss” (a loss is only when you sell, if you buy right, and just sit tight, until things improve well enough to be were you wanted to exit the “trade”, if you considered it a trade). After all, who ever foresaw a covid situation like we now have, with the world basically locked up for months? Covid provided many excellent entry points for patient investors willing to wait on the side line with cash that provided zero return, because the proposals from Mr StockMarket were all very expensive before covid. That’s how the world runs: buy low then sell it high to some novice/fear of missing out person/perennial day gambler, unless you want to keep the bought security for it’s nice dividend stream and share price upward potential, which are the two profit sources for those instruments. By the way, Jonathan, planning a third wedding soon ? Maybe write a blog post about how to get a good prenuptial contract, just to see if the spouse marry you for your (remaining) money or purely out of love and altruism. Since you are a very creative and smart money person, I am already looking forward to reading it all . . .

David Powell
David Powell
7 months ago

Unlike selling, *buying* Puts can be a useful tool to hedge some impact from big drops in your tech employer’s stock when you have regular vesting and Mr Market has been on a bender. Their rising value, as share price falls, lock in better sleep.

David Baese
David Baese
7 months ago

This article makes me feel so virtuous Jonathan! That doesn’t happen very often. Thank You.
Dave

HannahKatz
HannahKatz
7 months ago

The company stock ownership point hit home for me. My mother worked for a natural gas company that was later acquired by Enron. She had lots of Enron stock as a result, and my father bought more. They lost it all. WorldCom also comes to mind.

Roboticus Aquarius
Roboticus Aquarius
7 months ago
Reply to  HannahKatz

I’m sorry your family had to go through that. Thanks for sharing what must have been a very painful experience.

Subhajyoti Bandyopadhyay
Subhajyoti Bandyopadhyay
7 months ago

Jonathan, I remember an article by you in the wsj where you talked about buying a variable annuity for your children. And how it would be a good present for them from their old man at their old age. Or am I remembering wrongly in my old age?

Jonathan Clements
Jonathan Clements
7 months ago

I did do that. I purchased Vanguard’s low-cost policy and, so far, it’s turned out very well for my kids. That said, I now have some concerns, because Vanguard has handed over the administration to Transamerica. While the VA still uses Vanguard funds, I fear that may change down the road.

Subhajyoti Bandyopadhyay
Subhajyoti Bandyopadhyay
7 months ago

Well, following your column, I did the same for our child, and ditto. And ditto about Transamerica. So much so that I am now thinking of transferring that to Fidelity’s offerings. While the index options are not that extensive as those from Vanguard (just five – sort by lowest expense ratios), the ones that are there offer wide diversification and quite low costs (from 0.10-0.17%) apart from the 0.25% tacked-on management fee. That compares very well with Transamerica’s own fee structure.

https://fundresearch.fidelity.com/annuities/category-performance-annual-total-returns-quarterly/FPRAI

greglee
greglee
7 months ago

Buying insurance to cover all your risks is a fine strategy if you have an unlimited supply of money to pay all the premiums. But if you aren’t rich, it is more rational to take into account the level of risk. Not being a rich person, I went for the first half of my working life without health insurance. In retrospect, I still think that was a reasonable decision. In my 50s, I decided to start health insurance, which was fortunate, since in my 60s I was diagnosed with colon cancer. That would have cost me a pretty penny without insurance.

Joey
Joey
7 months ago
Reply to  greglee

Congrats on being a cancer survivor! Health, unlike how carefully you drive, is tough to control. You can be hit by a car or fall down the steps or get cancer at any age, so it not having health insurance through your 40s definitely is a risk, if not a gamble. Did not having insurance affect how you spent your youth (for example, fewer vacations,. no risky hobbies like skateboarding or mountain climbing or even running)?

greglee
greglee
7 months ago
Reply to  Joey

No, not having health insurance did not affect how I spent my youth. But my bout with cancer did teach me that there is no real alternative to dealing with risk, and one should not turn away in horror at every perceived risk. For instance, I had to decide after surgery whether to do radiation and chemotherapy, which have their own risks, to make it less likely that the cancer would recur. All my doctor could tell me was percentages of how many had died with and without the options. You just have to evaluate the risks and decide.

Roboticus Aquarius
Roboticus Aquarius
7 months ago

I’m liking the possibility of retiring early, so I’m having to think about that closely. The margin of error is way too thin yet.

Other common ways to go broke slowly is to buy too big a house, or spending too much on cars.

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