by Archie M. Richards, Jr., CFP^®
December 19, 2005

Many financial problems accompany a divorce. But stress is high, too. The stress leads to poor financial decisions, which worsen the financial situation, which worsens the stress. It's a downward spiral.

Take on the stress first by obtaining counseling. You don't have to be off your rocker. You just need a temporary friend to help you think straight.

Here are a couple of common emotional matters relating to divorce:

• Splitting up makes everyone miserable. Some people want to make things especially hard for their former spouses. But revenge makes a bad situation worse - especially on the children. Custody fights hurt the children most.

• A divorced person's social life changes. Married people are most comfortable with married friends. Single people want single friends. Divorced persons have to find new friends at the very time they need friends most.

  Okay, now for some of the financial issues:

• Maintenance payments are deductible by the paying spouse and taxable to the payee spouse.

• Child support payments are opposite: They're not deductible by the payer, but they're tax free to the payee.

• One spouse might have minimized a career to raise children. The settlement should provide extra money to the homemaking spouse to pay for additional career training.

• Let's say the wife relies on the ex-husband for child support, retirement benefits, alimony or college education. But if the husband dies, the wife is left holding the bag. She should acquire life insurance to protect against her ex's death. Since the husband's liabilities probably won't extend indefinitely, inexpensive term life insurance should be sufficient.

• The spouse who has custody of the children is inclined to keep the house. But be sure to consider the long-term effects. Let's say, for example, that the two parties split things equally: The wife keeps the house, and the husband keeps the retirement accounts, both valued at $400,000.

Whoops. The house is a cost burden and cannot easily be sold. But the retirement accounts are growing assets that can be sold quickly. The 50-50 split wasn't equal at all. Retaining the house may be too much for the custodial parent to handle. Selling it and splitting the proceeds would work better.

Divorce is complicated and stressful. Counseling helps you to take on the financial issues rationally. But consider the financial decisions in terms of their long-term consequences.

Hank writes, "I just started investing in the 9 Vanguard index funds you've recommended, including 20 percent in bonds. But I heard the founder of Vanguard say on television that a person's percentage of bonds should equal his age. I'm 57 years old. Should I increase my bonds to 57 percent or continue with just 20 percent?"

20 percent is enough, Hank. John Bogle, Vanguard's founder, is a great guy, but in this case his advice is wrong.

On a year-to-year basis, bonds fluctuate less than stocks. But in every single 10-year period over the last eight decades, stocks, after adjusting for inflation, have done better than bonds. In a few 10-year periods, both lost, but stocks lost less.

You're only 57. Plan on living to age 100. But no matter when you rise to your reward, your investments will stay right here to benefit others. Plan on your investment-time horizon having no limit, especially if you have enough to live on in retirement by withdrawing no more than 5 percent a year.

The essential way to cut risk is diversification. Mr. Bogle implies that as a person ages, diversification would be reduced. If you lived to age 100 and followed his advice, you'd have every penny in bonds. Your heirs would think it crazy to reduce the growth potential so much, and so would I.

Bonds in themselves are inferior to stocks. But you should include them in your portfolio anyway because their price fluctuations don't coincide with those of stocks. The lack of correlation cuts risk and increases returns.

But don't overdo the bonds. Twenty percent is enough.