Manage a Windfall Successfully - Ch 15 Bogleheads Series at Catch a Gideon

November 22nd, 2006 by digerati

This is Chapter 15 in the Bogleheads series here at Catch a Gideon. We are going through each chapter in the book and letting you know what we learned from reading it. You should buy the Bogleheads Guide to Investing. It has more examples and more depth than I’m giving here, and is overall an excellent investment book.

Over the course of a lifetime, most people will come into a lump sum of money. These sums come from inheritance, lotteries, signing bonuses, divorce settlements, lawsuit settlements, insurance settlements, stock options, real estate sales, sudden growth of a business, sale of a business, new job with higher income, retirement.

NBC News recently reported that over 50 percent of windfalls are lost within a short period. 70 percent of lottery winners exhaust their winnings within 3 years (most end up in much more debt than before).

Windfalls are About More Than Money

Money is about more than its value; it is a power symbol in our society. It is important to many people to appear to have more money than they actually do. People end up buying cars, houses, and clothes they cannot afford for these reasons. How people spend their time is a better indication of what they value most.

Receiving a large amount of money is also about the emotion involved. These can range from ecstasy (lottery) to depression (inheritance). It is common for windfall recipients to feel inadequate, stressed, and paranoid. The following four steps will help you mange successfully.
Deposit the Money Until Emotion Wears Off

Emotion will accompany the windfall, without fail. These last usually about 6 months. It is important not to determine what to do with the extra money until the emotion wears off. Take a small amount to celebrate. One or two percent should be sufficient. Also pay off any high interest debts like credit cards. You may also have taxes due on the amount, and those should be paid. You can place the money in a high yield savings account until the period is over (or until the taxes are due).

Do not do any of the following:

invest in “can’t miss” investments
lend money to friends or relatives who try to treat you as a bank
buy a luxury home (or car) to impress your friends and say “I’ve made it”
take expensive trips
go on shopping sprees
make large donations to favorite charities or causes
buy a boat, plane, or other expensive toys
quit your job

You may be able to do these things, but now is not the time. Wait until emotion passes and then begin planning how the windfall can be managed to best utilize what you receive.
Know what you can buy

People are often surprised how little $1 million will buy. It is not to say that is not a good sum of money, but when you are using it to buy expensive toys and unnecessary items it does not last long.

It is also important to know what you will actually receive. If you get the money as a direct inheritance you will most likely pay income taxes on the amount. That can reduce the total by nearly half. Special circumstances may prevent taxation on what you receive.

You should also determine what the amount (after taxes) can get you. $1 million after taxes will buy only a fair sized home, not the giant country estate many people imagine. Also, you need to plan the maintenance and upkeep of what you will buy. A Ferrari may cost only $200,000, but it may also cost $15,000 a year in maintenance. It’s alright to buy expensive toys like that if you can afford them, but most people buy them and cannot afford them.

Make a wish list

Once you have a realistic assessment of what you receive you can being to plan what you’d like to do with it. It is important to take time to assess what you’d like out of life. Determine how you would like your life to be different and what you would do if money was no object. Would you quit your job? Would you buy a sports car? Where would you live? Determine these factors for now, in a year, in 5 years, etc.

Then take the dreams and turn them into goals. Make lists of short-term, intermediate, and long-term goals. Then rank the goals by importance and develop a plan to best use your newly found resources. Determine things to as great of detail as possible. If you want to quit your job, can you do it now? Or is it better to do it in 2 years?

Get help

Unless you are knowledgeable in the areas of finance, estate planning, and tax planning, you should probably seek the help of experts. A good CPA may be the best option to help plan the use of your new assets. They can do the following:

assess your overall financial wellbeing
calculate any taxes due on the windfall
recommend any additional types of insurance you may need or what you currently have that can be dropped
help decide if the services of an estate planning attorney will be needed
calculate if it’s better to take alump sum payment or a monthly distribution
give a clear picture of how the windfall can help you achieve your long-term financial goals.

If you haven’t bought The Bogleheads Guide to Investing you should do it now (click the link!).