The Planner's Perspective: That One Bad Financial Decision
By Paul Morrone CFP®, CPA/PFS, MSA
You’ve done the unthinkable and made that one big financial mistake that you will remember for the rest of your life. The question is, how to recover from it? Maybe you bought a house that you couldn’t afford and now it’s underwater. Maybe you racked up credit card debt that is now uncontrollable. Maybe you made a bad investment and lost all of your capital, started a business that failed or loaned money to someone who you now know will never pay you back. What are the next steps, what can you do, and how can you right the ship?
Understanding where you are currently and what got you there will help shed some light as to how to move forward. Take all the financial and emotional baggage and lay it on the table. With the skeletons out of the closet you can now start to assess the damage and quantify your potential loss. This part is key to determining what to do next, and while you may not be able to determine the amount down to the penny, assuming a worst-case scenario will help you plan for the worst and hope for the best.
Once you’ve quantified the loss, you will then have to think about your options to remedy it. Sometimes the ‘rip the band aid’ approach may work best. A quick, painful, fix in the short term that may yield long term benefits. Other times, you may need to accept the concept of deferred gratification, where a remedy that is immediately available is too costly or too damaging to consider. Looking on the bright side, there may be a tax benefit to losses from business or investment activates, but you likely won’t see any benefit from bad personal decisions.
In addition to the dollars and cents impact, there are also several ancillary factors that need to be considered. Taking extreme steps (bankruptcy or foreclosure, for example) can have a lasting effect on non-financial factors such as your credit score and ability to borrow money in the future. On a more personal note, maybe you will have to make a hard decision that will impact your relationships with those that you care about, family members or close friends. Business owners may have to make decisions that affect their partners, employees, customers or even their reputation in the community at large.
The hardest part of the process is removing the emotion and objectifying the losses in order to quantitatively assess the various possible outcomes. Chances are emotions (overzealousness, love, fear, etc.) are what caused this loss in the first place, and it is safe to assume that emotion is not going to get you out of the woods. It’s akin to holding onto a losing stock that you think ‘has to bounce back’ simply because you bought it at a higher price and then it tanked. If you’re feeling this way, it probably won’t get better without action on your part.
Once you’ve chosen most prudent course of corrective action, the job isn’t quite over. With an outcome now known, you need to determine how your overall financial plan has been affected. If the monetary loss is substantial, you may need to alter spending habits, modify savings targets each year or sell other assets to cover the loss. This may also result in an updated investment allocation and modification to your overall investment plan. If your loss was business related, this may mean that an entity may need to be dissolved, formation documents updated or buy-sell provisions revised to accommodate the new set of facts. On a personal level, it may be wise to review gifting plans, update estate documents and review fiduciaries to ensure that you’re moving forward in the correct direction.
While it will ultimately feel good to cut your losses and move forward in a positive manner, closing your eyes and pretending it didn’t happen will not solve any problems. Without modifying and updating your personal financial plan, you are leaving the door open to making the same mistakes again in the future.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.