Jane was having the time of her life. The family business had been successful over the decades and she and her husband, Ralph, were enjoying all the things they’d dreamed about. They enjoyed travel, helping the kids and grandkids, supporting her favorite non-profits and frequenting expensive restaurants. She’d even become accustomed to driving the most luxurious of cars.
Unfortunately, just a few years later, she found herself living on a combination of social security and monthly withdrawals from her retirement account. Her lifestyle was nothing like she’d imagined it to be and she was starting to worry that her money wouldn’t last her the rest of her life.
What happened?
Ralph’s health had taken an unexpected turn for the worse and Jane found herself a widow. Ralph had also been the one who had managed the family’s finances. Jane is an exceptionally bright woman, but had never been interested in the family’s investments. She was suddenly responsible for making decisions she had never faced before and found it rather stressful.
How had her financial status declined so much, so quickly? Jane had made some simple mistakes, ones I’ve seen investors make time and time again over the years. If you find yourself in a similar situation, due to divorce, inheriting, having been widowed, or otherwise making new and important financial decisions, you may benefit from these two cautionary items.
1) Overspending: Jane had no idea how much she could afford to spend, so she spent freely, especially in the first years after Ralph’s death. She purchased a second home in another state. Next she began helping her children and grandchildren significantly. She helped them buy homes they couldn’t afford, took the family on expensive trips and financed education. Her investment portfolio simply could not sustain her spending. She quickly spent down some of her principal. Less principal meant less income could be generated and created a need for her to spend even more principal to maintain her lifestyle. This is a downward spiral that is almost impossible to stop without some serious cutbacks in lifestyle. Few people can make that sort of downward adjustment.
One solution? Be patient. Don’t make any significant financial decisions for several months. While emotions are high, we tend to take actions we might later regret. Jane did.
2) Jane imitated Sir Isaac Newton. In the 1700s Sir Isaac Newton saw all of his friends getting rich investing in the hot stock of the day, the South Sea Company. He decided that he too wanted to get in on the action, and bought into the company just before a great decline. He lost everything. Sir Isaac Newton may have been the most intelligent man of his time, but that did not translate into investing prowess.
Jane did something similar. A well-meaning friend encouraged her to place her money in his favorite investment at the time. He was excited about the prospects and his enthusiasm convinced Jane that this was a good idea. Unfortunately the friend was not familiar with Jane’s risk tolerance, time horizon, investment objectives, or full financial status. Both Jane and her friend were essentially flying blind. Jane made this – and some other – poorly timed, ill-advised investments and lost money she could not afford to lose.
Listening to the wrong people, no matter how successful they seem to be, can be disastrous to your wealth. Later, Jane learned that her friend had only invested a small amount of his net worth, whereas Jane had risked a much larger portion of her own. Over time she also learned that while her friend was financially successful, it was because he had built and sold a business. As an investor, he didn’t do well over the long haul.
Eventually Jane found herself selling off art and other items she had accumulated to finance her lifestyle. The day finally came when she had to face reality. She sold her beloved home, downsized and moved on.
If you find yourself suddenly having to make big money decisions, take a deep breath, slow down and don’t feel pressured to do anything immediately. Be careful who you listen to and adopt frugality, at least for a while.
This is a hypothetical example for illustrative purposes only.