Do you ever wonder why you or people you care about repeatedly make risky investments? We both know it isn’t because risky investments pay off – they don’t. So why are people drawn to these schemes even though they have plenty of experience that tells them to stay away?
I’ve noticed that the same individuals continually get caught in the same trap time and time again. Why? I have concluded that it is because either they spend too much or they don’t make enough money. This problem comes up even more when people are short of retirement income. Let me explain.
Just today somebody asked me about an IPO that is coming out in six months. While the company in question is certainly exciting, there is no guarantee that the IPO will be a good investment. I asked my caller Louise why she was interested in the IPO.
“I have to make up for all the investment losses I suffered last year,” she said. When we examined the records, it turned out that Louise lost 2.8% for the year. Losing money is never something to get excited about, but a 2.8% loss didn’t justify her fear. I asked her why she was so focused on making up for the 2.8% loss. She told me that she needed the income.
It turns out that Louise, an able-bodied 45-year-old woman, didn’t have a job and hadn’t looked for one for more than five years. She had a sizable portfolio that had done nicely over the years. But she was living off her portfolio, and it wasn’t large enough to support her. It never was. She clearly didn’t understand how much money you need to retire.
Her choices were:
- Earn more.
- Spend less.
- Create more portfolio income by quickly increasing her capital.
Because she chose option “C” she started making risky investments. She wanted to make a lot of money fast. Because she totally rejected options 1 and 2, she really gave herself no choice other than to do so. So at the end of the day, her poor spending/income relationship was pushing her towards making rotten and risky investments.
How can you use this information?
The first thing to ask yourself is how are you investing? Are you buying risky deals? If so, why? Are you trying to make up for past losses? And if that‘s the case, why do you feel you must make up for those losses so quickly? Investing well is a very long-term proposal. If you are investing for the quick hit, you are speculating. Over the long run, that can lead to disastrous results.
Don’t get me wrong. You may have a great hunch about an investment, but your spending/income situation shouldn’t drive you to make risky plays.
Do you know who plays the lottery? For the most part, it’s poor people. Do you know why? Because they are desperate to correct their imbalance between income and expenses. Do you know what the result is? The imbalance becomes greater.
How to Get Off this Merry-Go-Round
The most important first step is to get your spending under control, and you can best do that by starting to track it. I use budgeting software, but you don’t have to. It doesn’t matter how you do it, but it certainly matters that you do this.
What else can you do?
Portfolio income is really nice because it’s passive. You can sit home and watch Oprah all day long, and those checks will still come in. But if your capital isn’t large enough to sustain you, you’re going to have to TiVo those Oprah episodes and get to work. And if you aren’t making enough from your job, you have to consider other options.
- Is it time to change your career to earn more?
- Can you launch a side business?
- Can you spend less money?
After 25 years in the business, I never understood how poor income and spending could lead to terrible investment decisions but now I get it. If you want to reduce your chances of making bonehead investments, make sure you have maximized your income potential and minimized your spending first. That will solve 99% of your problem.
Do you continually make lousy investments? Why? Are you trying to make up for poor decisions from the past? Are you trying to catch up?