Risks, rewards & bankruptcies
Wealth is rarely generated without someone taking some form of risk. It might be the purchase of real estate, a business venture, etc. If you have a positive result from this, you could become wealthy. If you fail, you could become bankrupt. Let's talk about the balance of life risks and risk mitigation.
There is no progress without risk.
Let's accept that this is the way of life. Every day you wake up, you take a risk. If you never leave the house, your risks are lower. But you never have life experiences that are profound. If you don't invest in something, you won't get a return. Even putting your money in the bank with a minor return on it carries the risk that the bank doesn't abscond with your money, go broke or the funds are seized by a failing government, etc. Risks are part of life. If you don't accept them, you don't live.
How much risk is enough?
Some people have the stomach for more risks. This can manifest in people who love extreme sports, want to climb Mt. Everest, skydive, etc. We get positive psychological feedback from adrenalin rush that comes with risk taking. That's why roller coasters are so popular. It is the rush that you get from stepping out of your comfort zone.
Other people want no risk. They strive for predictability, and get predictable results. By following in the path of someone else that has already cleared the way, they see that the risks are smaller because someone else took those risks. This can create a "herd like" mentality, where those who want minimal risk will just follow the herd down a path. For those wishing to achieve financial sustainability, we see this as the very worst possible scenario because you will get the same results as everyone else, and you will be an easy target for those wishing to extort wealth from a large group. I mean one level of effort targetted at a large group means the extortionist has an easy time to get maximum reward.
And then there is the concept of having a story to tell. If you live a boring, predictable life, are you maximizing the opportunity that life gave you? Are you just slowing meandering through each day with no real goals, no real journey? Is that the best YOU that you can be?
Learning to know yourself better
I have friends who are big risk takers. They live a life full of experience and they embrace risk as a cost of doing business. They have the greatest stories to tell, and they live a rich life.
I have other friends who have no stomach for risk. They want to work in a predictable and safe job, live in a predictable and save neighborhood, have a safe family and have routines. Breaking free of the routine scares them, so they choose not to do that.
Neither are right or wrong. What is right is that the individual recognizes their preference for risk and lives their life authentically and in coordination with the knowledge of their comfort zone. What is wrong, however, is that the individual only strives for comfort and never learns what they could be. That is laziness and that is wrong. If you have the capacity to better yourself, it is in the human spirit that you should do that. If that means taking a risk, you have to learn how much risk you can handle and move forward accordingly.
When education really occurs
You might think that spending decades of your life in school, university or ongoing study is the only education you need. Wrong. Education comes when you insert yourself into the world and fail.
Yes, that's right. Fail. This is when you really start to learn. Because you are faced with having made bad decisions, mistakes, or third party intervention that forced you to realize you failed. We joke at failures but the reality is that those that are failing are actually learning more than those that are not. The profound nature of failure is when you really start to take notice and learn.
Do you think that I would have the right to write these articles if I hadn't been "around the block" and failured many times in my life? It is from those failures and a willingness to debrief myself afterwards that I truly lived. I criticize those that preach their story and try to tell others how to live their lives, or invest their money, or follow a path, if they have never failed before. Because those that haven't failed, haven't really left the world of study and ventured forth into the world of reality. Never take the advice of someone who has never failed.
Venture capitalists know this. If you look at the methodology of investing in new startups, they really only want to invest with people who have failed before. That is because they know that the failure was the true education that will likely not repeat in the future. So know that you will fail at some point. And that failure isn't such a bad thing at all. With it comes true wisdom.
What to do when you fail
In the western world, failure is typically felt in financial terms. You can go from zero to hero, and then back to zero, based on your financial choices. This is because we live in a world of debt and debt has become a new currency. It isn't how much money you have in savings, but how good your FICO score is. If the computer says you are worthy of debt, then in the USA in the 21st century, you can pretend you are rich. You can get access to capital that allows you to take on the risk of having to pay that back. If you fail, then your score drops. It is a very sick thing that we are measured in terms of our ability to take on debt and pay back those that provide us with that debt, as if that determines the character of the individual. And yet those that choose not to take on debt and fund themselves out of sheer work are measured lower in that score.
But sometimes you take on debt, and life happens. Divorce, health issue, car accident, job loss, etc. and you now can't pay the ongoing costs of servicing that debt. Some will look at you and judge. They will say that you should have never taken that loan in the first place. That you bought too much house or too much car or too much whatever. That you have run up large credit card bills, etc. Typically those that say that are projecting their own failures, but be that as it may you have to deal with this situation. We call those things "adverse events". You don't want them, and more likely an outside influence affected you - you didn't choose to have a car accident or a job loss. It happened because of things outside of your control.
You should never seek out failure, and you should mitigate risk so that when you fail (and you will at many points in life), you can recover. But know that the deeper the chasm that you fall into, the more education you will get to dig yourself out of it. But don't seek out that failure. Particularly if your actions will hurt or impact other people you care about. You have the responsbility to look after their best interests even more than your own.
The most likely situation you will immediately find yourself in is that those with vested interests in money that you have to pay back will reach out to contact you. Initially it might be some robo call or letter acknowledging that you are not in compliance with some contract or agreement that you made, and that you have the responsibility to make this right. That means they want their payments and your failure to make those payments will have some reprecussions. The level of reprecussions will be determined by the type of debt.
If debt is secured against something (ie. your mortgage is secured against your home, your car loan is secured against your car, etc.) then the creditor has the right to seize the security. That could be a foreclosure or a repossession of the security. You may still have a way to avoid this with negotiation as the creditor doesn't necessarily want the security, particularly if it is going to be sold off at some fire sale and it is less than the value of your debt. But that is not a decision you have any power over. That is their policy and you have to respect it. After all it is their money that you are not paying back.
The thing is that despite the lenders making countless offers and trying to guilt the public into thinking that they can't live a rich lifestyle without some gold credit card, the truth is that this is about them making a % return on money. Our society has turned to one that used to be based on real assets and savings to one that is based on debt, because it is far more profitable to lend money than it is to receive and store money and pay the owner of the capital a fee (savings interest). Banks know this and over time they have done deals with government to not only enslave the government into debt levels never before seen, but as part of that unholy alliance, they are given the power to lend vast amounts of money to people that are probably ill-equipped to pay back the loans. This is the root cause of what happened in the 2008 financial collapse and the recession that followed.
But let's get back to you. If you find yourself unable to service your debt, then you have some options.
The lenders want you to continue to pay them interest. If they are making 25% interest on a credit card, and fees, etc. they are doing really well financially. They often target those that have little ability to pay back loans through pay-day lending or title loans, because they make far higher interest rates in that debt. Compare a 30% return on a loan vs. a 5% mortgage and you can see why the lenders would favor offering the higher interest products. But if they have no security on the loans, they might be willing to defer payments for some period of time in lieu of writing it off. Your ability to communicate with them is key here - hiding under a rock living with the failure is the worst thing you can do because they will be inclined to do drastic things if they think you are not communicating with them.
No one wants to default on an obligation (well maybe some really bad, evil people do) but sometimes you have no choice. If you have no money, you may have to default. It really comes down to what the downside of defaulting is. You know your credit score will take a massive hit. If you have been late on payments already, that probably has already happened. If the debt is not secured by anything, then the default may not be financially too drastic for you, but that won't stop the creditors calling you and harrassing you. Why do they do this? Well because you probably have multiple debts you are defaulting on, and they want to be the one debt that you choose to pay so that they go away. The more active and loud they can be to harrass you, the more likely you will pay them off first to get them out of your life. It is a psychological ploy and one that really is hard to deal with. Especially if it involves other parties like spouse, kids, etc. that get caught up in this.
If your debt has some security to it, then you will lose that security. Don't think that you can hide the asset that secures the debt. You can't. They will find it and they have the most ingenious ways to find it - particularly cars. They will use social media, social engineering and trickery to get those closest to you to tell them where the car is. It is unlikely that you will win with this. You could give up the asset voluntarily if you can live without it. That might be the best option, but they will still pursue you for the deficit of the debt value less the asset value (if they can legally).
Mortgage debt is the scariest debt to default on, because no one wants to be kicked out of their houses. However just like rental contracts, if you default and the matter is processed through the courts, you will eventually have to leave and typically your reluctance to leave will not work. Courts will pretty much always side with the creditor on a financial debt obligation, and they will issue a "judgment" that the creditor will get. The judgment will entitle the creditor to seize the assets and gives the creditor a simple path to pursue you further through the courts and to use the power of the courts (including court offiers, ie. police) to forcibly remove you from the residency. Depending on where you live, since the courts are regional, the time period for this will vary. In some states, for example Arizona, a default on a rental contract typically results in a court officer forcibly removing the tenant from the premises within 30 days of default. Other states have different policies.
The concept of bankruptcy is to use the legal system to provide you with some form of legal discharge of debt. This is typically a drastic method used, but it typically can be used once every 10 years or so. Again, this is not legal advice and your situation and region will have different laws, so you should consult with an attorney for advice specific to your situation. But in general the concept of discharging of debt means that the creditor no longer has the legal authority to pursue the debt on you. This "get out of jail free card" is something that you may need to take in some dire situation. But with it will come certain rules of what you have to give up, what you can keep (usually pretty limited), etc. so that you can move forward again. If the court is going to rule that the creditor is forced to take a loss, they will make sure that you don't get off without some financial hardship. You will be forced to give up any assets you have, etc.
Some debts can never be discharged
This is where it gets really scary. Debt obligations for student loans can not be discharged in bankruptcy. Nor can tax obligations. These two things are important considerations as to what your options are. And also the student loan issue is why bankers lobbied with governments to create an alliance that benefits them. They get a debt that can never be discharged, which means minimal risk to the bank. Meanwhile the universities got the right to expand, offer more expensive options, etc. knowing that they will get paid regardless. Students at the age of 18 when looking at what college to go to, are not equipped to make financial decisions of this magnitude and rely on parents to guide them - parents that often are shouldering their own debt obligations unsuccessfully and unable to advise anyone about money.
Depending on the conditions of the loan, payments for it may be deferrable but this often opens up interest rate increases, etc. and results in extending out the loan into the future. It is not uncommon to find those than spent a large amount of time in expensive colleges to be shouldering hundreds of thousands of dollars of debt which may take 15 years or longer to pay off. Most mortgages can be paid off on houses in shorter time periods.
Then there are tax obligations. When you earn money, you may be subject to taxes. This can come in the form of you making a tax return and paying the taxes, or that the government body elects to determine your taxes (and possibly penalties) if they either don't receive a tax return from you, or they disagree with your valuation of taxes. The rules are regional and you need to hire professionals to assist you with the valuation of tax amounts. If you are employed, taxes are automatically deducted from your wages before you receive your money. If you are self-employed, then you are responsible to make tax payments (typically periodically) based on your measurement of taxable liability.
Tax agencies can be very harsh to deal with, yet with the right approach you may be able to negotiate the debt level with them. Again, consult a professional before engaging if you have tax debt. But more than likely you will be paying it back in some manner.
Most people that choose to go to law school do so for decent reasons. They want to represent those victims of society in court. They want to learn the law and that knowledge is power. They also make a lot of money. But some of them are only interested in the money, and that means that ethics and decency are never really considered.
In the 1990s, we produced a situation where there were too many attorneys graduating from college. The "out of work attorney" problem resulted in attorneys looking for ways to make money. One of the techniques that was commonplace was to find those with debt obligations and to use the court system to manipulate them into losing their assets. It is rare that small business owners or individuals have the financial capacity to fight in a court. Although they have the right to do so by representing themselves, they are advised not to. This is because it is easy for a mistake to be costly in court. But if you are an attorney, you hold all the cards here. Not only do you know the law and how the court system works, but it costs you nothing other than time to engage a defendent in court. Attorneys know this, and there is a lot of blatant misuse of the court system to increase the wealth of those attorneys.
Cases that parties had against other parties are often taken "contingent", meaning that the plaintiff party doesn't have to pay the lawyer for their time until the case is over. Often the lawyer knows ahead of time if they can win and what they will get, so they negotiate a % fee of the resulting award rather than an hourly rate. It can be high - 30-50% is not uncommon, but considering that the plaintiff doesn't have to outlay money for the attorney, it might be worthwhile. This is particularly true of cases where there is a lot of historical precendents already in place. For example, suing insurance companies for bodily injury is usually pretty much a guarantee for the attorney, so you see signs everywhere about "Attorney X wil FIGHT for you" if you have a car accident, or a workplace injury. This is because the awards are usually very high and a large percentage of that award can make an attorney an instant millionaire.
In the case of civil proceedings it often comes down to whether the defendant has assets. If an attorney charges $350 an hour, and needs to spend 100 hours on a case, then you need to know that their fees and much more can be recouped if you are willing to pay them to represent you. The defendant better have the ability to pay a judgment because if they can't, you not only lost as the creditor not being paid, but now you are out the costs of the attorney as well. Therefore smaller debts are usually settled out of court rather than fought in trial. But larger ones, particularly if the defendant has assets, may be pursued by an attorney.
Attorneys are realists. They won't enter into a fight unless they know they can win it. The exception to that is whether their client has the ability to pay them, and if that is the case they will just charge fees to the client to represent them but the outcome is 100% on the shoulder of the client.
Are you an attractive target?
What if you did nothing wrong? What if you paid all your debts on time and were in good standing with your creditors? What if you actually were successful and had amassed weatlh? But you are still sued by an attorney?
This is something I see commonly in the FI community. The level of naivety is huge. There are websites that lists those pursuing FI and how much they have accumulated in assets. They are openly bragging about this to their peers and using it as motivation for others to pursue wealth generation. But they have never been around the block. They are WAY too trusting, and there are evil attorneys out there that see how much money they have and want to get that money. If you openly advertise how much you are worth, you are stupid. Because someone else is going to steal it from you. That is just how life is. If you don't believe me, you will become part of the "fool and their money don't stay together very long" adage. You are the fool.
You see if you are worth $1 million, and you openly tell people that, then it will be stolen from you. Thieves target those with assets. They are not interested in breaking into a house that has nothing. The risk/reward ratio is not good for them. But if you openly advertise wealth on the Internet, a simple Google search will allow them to see that, then target you. Try this yourself - type your name into Google and see just now much information is out there about you. Your home address, your phone number, etc. Most of this is publicly available to the theives and the evil attorneys. And there you are - bragging to your FIRE friends of how much you are worth. What an idiotic thing to do.
Having said that, there are many ways to avoid being a target. Think of it this way.... A theif is driving along your street working out which house they are going to break into. One house has a sign out the front saying "Protected by XYZ alarm company". The house next door doesn't. Which one do you think the theif is going to go after?
The same is true in regards to being a financial target, however in this case the theif is not some guy in a balaklava breaking into your home. It is an attorney in a suit, extorting you for money through the court system. There are many attorneys that use loopholes in the court system to target those that are honest, hard working individuals. Patent law is one of the worst examples of this. They would file these ridiculous patents against things that are commonplace and our government just processed the application if it was filled out correctly on paper without reading it. We had people filing patents on podcasting, menus in restaurants, check-out on eCommerce shopping carts, etc. as things they invented or owned. Clearly these were not true, but since the patent office didn't review it in great detail they granted the patents and lawyers would buy up these patents from businesses that went broke and use them to go after people who they felt were targets.
They would first attempt to settle a dispute for hundreds of thousands. The defendant would not pay, but then the costs of defending could be $2 million or more in legal costs, so the lawyers would take the matter to a district that would always lean towards the attorneys and make millions extorting honest people out of money. Who would they target? Well those with deep pockets of course. And how would they know this? Simple. Do an Internet search.
There are a few things you can do here. As mentioned before, you don't make yourself a target by advertising your net worth. That is rule #1.
Second, you start to learn how asset protection works and study this. It is harder to do this today than it was 20 years ago, but the most commonly used method is internationalization. The only problem is that if you find yourself with a judgment against you in a US court, the creditor has the right to call you into a court proceeding for a "debtors review" in which, with a judge overseeing it, they can interrogate you as to what assets you have (worldwide) and if you fail to answer truthfully or refuse to answer, you can be held in contempt of court, which is a criminal situation. Basically you will be held in jail until you agree to answer truthfully.
But remember this is an extreme situation. It costs a lot of money for a creditor to go to these extremes and the more questions there are as to whether they will get a positive outcome from it, the less likely they are willing to do it. If you have debt, and there are too many variables as to whether the creditor will be able to get paid back, they may be more inclined to settle the debt amount with you for a small fraction of its value. It is that or they pay tens of thousands to attorneys and wait years in order to get some money. What would you choose?
One strategy many use is internationalization. Laws are regional. You have local, state and federal courts that oversee law in their region. But if you have operations and assets in many countries, in order for assets to be seized, a judgment must be made by a court local to the region where the asset is. The exception to this rule is when a judge can force you to disclose and give up assets that are outside of the reach of the court, by forcing your hand. However it takes a lot of work to get to that point.
And that is if the other prevailing party are even aware that you have assets outside the reach of that court. It is another reason that lawsuits are settled. The costs of pursuing legal cases across international boundaries literally doubles the legal costs because you need representation in both regions. And it doubles the chance of failure as well. Internationalization is one of the best methods to ensure that you are a less attractive target.
However that doesn't count for tax debt. The fact is that governments communicate about assets between each other. In the US, our laws state that income earned anywhere in the world is taxed under US tax law for any US taxpayer. This is a rare situation because most other countries don't do this. They only recognize taxable revenue in the residence of the tax payer. But not the US. Therefore US tax payers are expected to disclose foreign assets. The US treasury department requires any US person who has assets > $10K in total at any time in a financial year to file a FBAR report on those assets. Assets in foreign bank accounts that exceed certain thresholds further require disclosure through the FATCA laws. Banks are expected to file back to the US government information on US tax payers. Note that this information is predominately for tax burden and tax debt. This information is not commonly available to private parties or lenders.
So you may not have too many options for US government debt, but you can definitely make yourself less of a target by theives by not telling people what you have. Yes, I'm talking to you FIRE people. Shut up about how much money you have. For god's sake.
Risks are everywhere
If you want to have a meaningful life, you will take on risks. Whether that be borrowing money for a home, going into a new business venture, etc. there are risks. How you handle yourself through that will determine if you are wealthy or poor.
And the world is a dangerous place. Although you might think that you are relatively low in risk, your actions may invite theives to your door. And theft of wealth is commonplace in our world. It has been since the dawn of time - the difference today is that we have the Internet. Search Google for your name and you will see what other people see about you. This is a gift to theives.
That doesn't mean don't get out of bed in the morning. But know the risks before you do. We will talk further about risk mitigation in upcoming articles, but just be careful out there. Rewards come only to those that take risks, but be aware of the dangers of taking unnecessary risks.
I've said a lot in this article but I'm not giving any legal or financial advice. Consult with an attorney or CPA to get advice in regards to your specific situation. Do not consider this article as legal or financial advice.