How not to go broke

Ladies, liquor, leverage

I was having a yarn on Twitter this week with some smart finance types & recounted a Charlie Munger quote about there being only 3 ways to go broke: ‘Ladies, liquor, & leverage’.

Sidekick Warren Buffett quipped that Munger only added the first two because they begin with ‘L’, implying that that the only way people really go bust is through leverage, or over-extending themselves.

A switched-on follower pointed out that the Berkshire Hathaway chums were discussing this subject many years ago, before the advent of Betfair accounts & Bitcoin, which got me thinking about the question in a bit more detail.

A ramble through the myriad of ways in which folks become insolvent or file for bankruptcy – from being sucked into pyramid schemes, backing music tours, or being sued, to selling drugs, having an affair, spiralling medical expenses, or receiving (& then splurging) an unexpected lottery/inheritance windfall – saw a number of common themes emerge.

6 ways to go broke

While there may be some crossover between the categories, summarised below are 6 key causes of people being sent broke:

The company you keep is critical, for bad relationships (including poor advice from friends) are known to be a potential destroyer of wealth, while if you’re prone to ‘keeping up with the Joneses’ this may lead you to partake in an unfulfilling game of materialism that can never truly be won.

Some elements of risk come from within.

lack of knowledge about scams, investing, or business represents a pervasive risk, for example, while chemical & behavioural addictions can take numerous guises from substance abuse to shopping, & from gaming to gambling.

How to avoid addictions? A glib response might be ‘don’t engage with vices in the first place’ –  but in addition to abstinence qualified psychotherapists suggest treating the psychological dependence & investigating the root cause of the destructive behaviour.

Excessive leverage can take a range of forms but most often refers to debt, which in turn is often a factor in the placing of ruinous bets, including for budding real estate investors.

Aiming high safely – managing risk

Thinking big is a worthy outlook – aim for the stars then maybe land on the moon, & all that – but it’s not so ideal if you burn up on the journey.

Here, then, are 4 key ways to manage risk:

(i) Manage debt – ignorance is not bliss when it comes to financial obligations! Be familiar with the lender(s), terms, and repayment status of liabilities;

(ii) Stop worrying what others think – spending on stuff that isn’t really needed rarely helps the cause, so don’t go broke trying to look rich;

(iii) Read widely – educate yourself. Try to challenge preconceptions often; and

(iv) Diversify – the future is far less predictable than we tend to think, therefore all eggs should not be in one basket.

Ultimately it falls to the individual to manage the risks.

After all, no-one will care about your money more than you do.