Common ways in which everyday people lose money.
Investing in private businesses
Oftentimes, people starting businesses have no clue what they are doing but think that they do. Myself included. People lose money starting businesses because:
- It’s a dumb idea, but they are too stubborn / head-stuck-in-ass to realize it. People tend to be overconfident in their abilities and they tend to stick to a belief (e.g. their business idea is good) even when the evidence indicates otherwise.
- High risk does not mean high reward. It’s no different than a casino. When you play the casino, you have a negative expected return unless you really know what you’re doing. I would look at startup businesses the same way. It’s the startup business casino. Assume that the expected return is negative unless you really know what you’re doing.
I’ve started a business. I’ve seen other people start businesses… and lose a lot of time and/or money. Go watch Dragon’s Den and Kitchen Nightmares (UK version). A lot of money in the world is destroyed by the lure of starting your own business.
Yes you can make money starting a business. But it is much likelier that you will lose money. And it’s much easier to lose money starting your business than to make it.
If you buy and hold random stocks (or an index fund), you can make 6-10% per year. A few problems:
- Very few people actually buy and hold stocks. Most retail investors act like other human beings and experience fear and greed. They buy when everybody is “making” money and sell when everybody is “losing” money. They like to believe in conventional wisdom and tend to follow the herd. Studies on mutual fund inflows and outflows show that retail investors almost always lag the performance of their mutual funds by a significant amount.
- Most people don’t pick stocks randomly (or hold index funds). Stock-picking/market-timing/active-management talent is probably distributed unevenly. At least 80%+ of people in the world will be below average in stock-picking ability. By picking their own stocks, they are actually hurting their performance.
- The future may not resemble the past. It’s possible (though highly unlikely in my opinion) then stocks underperform your other investment alternatives. Anything can happen.
You should do fine if you own index funds and don’t hold too much of your money in stocks.
The other way to lose money in stocks is to chase a fad like tech stocks during the Dotcom Bubble. Especially if you borrow money to do it.
Complicated financial products
Such as market-linked GICs. It is almost always the case that complicated products are ripoffs due to adverse selection. The products are designed to be complicated so that you won’t understand them and won’t realize how you’re getting ripped off.
Investing in things you don’t understand is a bad idea.
You get a variable mortgage. Interest rates rise. Now you can’t afford your house.
Or, you are in the middle of a real estate bubble and lenders are so crazy that they give you a mortgage you can’t possibly afford (e.g. you have no job). This is why the US housing market is a mess.
Or, you decide to speculate on housing and take on an insane amount of leverage (e.g. down-payments on multiple condos at once). This happened to people I know (Hong Kong real estate bubble).
Spend too much
This is so obvious, yet many people in Canada/US have a negative savings rate. This is not sustainable.
Divorce, unforeseen illness, loss of job, etc.: Some savings are generally a good idea.
Civil war, communists taking over your country, war, discrimination, etc.: China and Russia alone represent a huge portion of the world’s population, yet a lot of people lost their wealth in these countries when communists took over. (This happened to my parents.) Even in democratic capitalist countries like Canada where I live, some minority groups lost all their wealth due to discrimination (e.g. Japanese Canadians during World War II).
Whenever crazy historical events happen, you should figure out if you should flee the country and if you can take some of your wealth with you. Maybe you can keep some wealth if you plan ahead and have some assets overseas or own physical gold in a vault. Or maybe not (e.g. border guards may take your gold). I have no idea what the future holds. But most conventional financial advice never consider these scenarios, even though such events have affected billions of people on this planet.