There were two families that lived next to each other. One family received a $2 million inheritance. They traveled, had a nice boat and gave to charity. They took calculated investment risks that paid off. They averaged an incredible 12 percent return every year for 20 years.
The other family did well but wasn't nearly as successful. A good year for them was when they made $75,000. They also took vacations and gave to charity, just not as expensive or as much. Although they too took calculated investment risks, they earned a more wordly 8 percent average return over the same 20-year time horizon.
Both families worked hard all of their lives, but it just wasn't enough for one of them. Which one? Common sense tells us that the family who received the inheritance and had a 12 percent investment return for 20 years was the "successful" family, and that the other family will have financial problems during retirement. Guess what? Common sense is wrong.
It doesn't matter how much you make, or whether or not you receive a windfall, what matters is how much you keep. There are a great many sudden wealth recipients who spend down there windfall -- the stats are alarming. A Sports Illustrated report titled "How (and Why) Athletes Go Broke" shows that 78 percent of NFL players are bankrupt or facing serious financial stress within just two years of ending their playing careers. And in the NBA, some 60 percent of players are broke within five years of retiring from the game. And according to a study in The Review of Economics and Statistics, the rate of lottery winners filing for bankruptcy within five years of winning is double that of the general population. And on top of that, 70 percent of families lost control of their assets in the first generation following an inheritance, according to The Williams Group.
One of the first rules we learn in multiplication is that any number times zero is what? Zero. A 50 percent, 100 percent or even 1,000 percent investment return, when it is not saved or invested, equals nothing. The family who earned less income and generated a significantly lower investment return amassed a fortune because they managed their liabilities -- their debt and their expenses. They made less but kept more.
Too often we focus almost exclusively on managing our assets when we should be spending time building our assets and managing our liabilities. Earning a 10 percent investment return instead of an 8 percent investment return isn't going to guarantee you financial independence, a great lifestyle and a successful retirement, as much as controlling your expenses and saving will.
The best way to get and keep your finances on track is to automatically shift income into savings and investment accounts each month, in addition to limiting those "one time" purchases that continue to require money - this is one of the seven deadly financial sins for those who win the lottery or receive an inheritance. Take into consideration not only the initial cost but also all of the ongoing costs. By putting your savings plan on autopilot and limiting ongoing expenses, you can be assured your assets and your liabilities will be managed appropriately.
(Robert Pagliarini is a CBS MoneyWatch columnist and the author of "The Other 8 Hours: Maximize Your Free Time to Create New Wealth & Purpose" and the national best-seller "The Six Day Financial Makeover." Visit YourOther8Hours.com.)