Is Your Business or Life A Debt Trap? Or Is Your Optimism Keeping You Poor?

The following guest post was contributed by by Neal Frankle, Certified Financial Planner in Los Angeles. He blogs at WealthPilgrim.com

If you would like to contribute a guest post, click here.

Ed, a friend of mine just lost his house and his business. It happened because he was too optimistic.

And as you’ll see, even if you own a thriving business, you owe it to yourself, your family and your customers to be a little pessimistic sometimes. Ed wasn’t. As I said, he was the exact opposite. Ed was the quintessential optimist and as a result, made decisions that ultimately cost him his entire business and home.

Ed owned a nice natural cafe in a growing suburb of Los Angeles. For years, he had the only natural foods café in town and saw business increase year after year. Being the optimist, Ed “knew” things would only get better and better. That was his first mistake.

In short order, several other natural food restaurants opened up nearby and they began eating Ed’s lunch. Since he hadn’t really done anything to develop a loyal clientele, customers dispersed and business decreased. He leaned on the plastic to “get him through” and soon found he couldn’t get out of credit card debt. He told himself that the business would get back to normal. Of course he quickly saw his good credit score deteriorate but he didn’t worry. Then the next wave hit.

Ed wasn’t making much money in his business but his investments were going great. In fact, by 2007 he was making more money on his real estate and stock market investments than he was in his restaurant. He decided to borrow $500,000 from a friend and use it to increase his investments in the market. Since this friend was “only” asking for 10% return, Ed felt comfortable going ahead with the loan. Of course, this was his second mistake.

Although Ed was successful with his investing, he never even considered the possibility that things could go against him. When they did, Ed got more aggressive with his investments. He did so with the hopes or earning more money faster and then paying off the loan.

Of course this didn’t work out. Both real estate and the stock market took a huge hit in 2008 and Ed lost half the money he borrowed. Since his business was just about kaput by that time, he had no way of returning the money he borrowed. In short order, Ed lost his business and his home. On top of that, he’s up to his eyeballs in IRS tax debt. Unless some miracle happens, it may not be long before he declares bankruptcy as well.

What can you learn from Ed’s story?

The main lesson is that it pays to be a bit of a pessimist when it comes to your financial future. I know that doesn’t sound very uplifting but my experience tells me it’s the truth.

Optimists are less inclined to buy life insurance yet they need the coverage just as much as anyone else.

Optimists are less inclined to have a “Plan B” but the truth is, we are all better served by having a backup.

Another obvious lesson is that you should never borrow to speculate. Never.

It can make sense to borrow to buy real estate if you can easily afford the payments. And it’s fine to borrow to invest in your business as long as you have a business plan.

Speculation is throwing money at something hoping for a very quick and large return and needing everything to work.

Investing is carefully considering the pros and cons and going forward understanding the downsides – and being able to survive if things turn out poorly.

In short, if you want to avoid the inevitable results that Ed basically created for himself, do the following:

a. Ask yourself where your greatest risks are? What needs to go wrong in order for your financial house to fall apart? Is it premature death? The solution is more life insurance. Is it a failed business? The solution might be getting a business coach, diversifying your business, reducing expenses, smarter marketing, having a much bigger emergency fund or a combination of all the above.

b. What financial skill do you lack most? If you are in debt, you are in the right place. Steve’s blog is probably the best place to get information on how to solve that problem. But how did you get into this problem? Do you need to track spending better? Do you need to rip up the credit and debit cards? If you are poor at making smart investments, do you need a financial advisor? Do you need to turn over your investments to your spouse and let them handle this for you?

I’m not asking you to walk around like Chicken Little. I am asking you to really think about what could go wrong and what you need to do today to mitigate those risks. As my friend says, there is nothing wrong with hoping for the best….as long as you plan for the worst.

Do you have a plan “B”?