You may have recently come into a large sum of money or expect to soon. Congratulations! This amount may be more than you have ever had in your life. Naturally, many thoughts and emotions may be swirling around your head, leading to questions like:
What should I do with all this money?
How do I protect it?
Is it wrong to spend it?
Windfalls are not limited to lottery winners and athletes with substantial signing bonuses. Many people come into a large sum of money at some point in their lives, and there may be a good chance you will, too, if you have not already. Some other common sources of windfalls include:
An inheritance,
A sizable income bonus or a new job with a big income increase,
Stock options,
A sudden growth in business or a sale of the business,
A divorce settlement,
A lawsuit settlement,
Becoming a widow(er),
An insurance settlement,
A real estate sale, or
A retirement payout.
When a windfall enters your life, it's crucial to understand how this new financial reality will impact you. Taking the proper steps can ensure that the funds enrich your life rather than leave you with regrets. Here are three steps you should take when a windfall comes your way.
Step 1: Deposit the Money in an Interest Bearing Account and Do Nothing – at Least for a Little While
A sudden inflow of money usually triggers a wide array of emotions, from euphoria to guilt to even depression, depending on the circumstances. It is common for windfalls to be needlessly misused while experiencing the emotions that come with them. Research from Ohio State University found that one-third of individuals who received an inheritance had negative savings within two years of receiving the money.
The good news is that the emotions of a windfall are temporary. Therefore, the most crucial step to preserving your recent influx of money is not to touch it until the emotions have had a chance to subside and you can make decisions more clearly and objectively. If you receive the money in cash, deposit it into an account and keep it very low-risk but still interest-bearing – a money market fund, treasury bills, certificates of deposit (CDs), or a high-yield savings account. If you receive an inheritance in the form of invested accounts, leave the allocations the way they are for a while. Generally, we recommend this 'leave it alone' approach for six months to a year, depending on your circumstances. When we advise clients in these circumstances, we tend to be cautious and recommend doing nothing (or relatively little) for twelve months and getting through the fiscal year. Some legal or tax issues may need to be sorted out, and acting too quickly could cause unwanted complications.
The goal is to avoid hasty, rash decisions with your new money. Frequently, individuals who come into a large sum feel like they need to do something or have a responsibility to take certain actions. It also makes you vulnerable to opportunistic family members or others. It might be to invest in a 'can't miss' opportunity or product, lend money to friends and family, buy something expensive and flashy like a new car, or go on a shopping spree.
Although you may be able to afford these things, this is not the time to do them. This is a time to pause, reflect, and gather information. Taking the time to find clarity allows you to let those impulses pass, figure out your priorities, and create a plan. For the time being, do your best to go on living more or less the way you did before the money arrived in your life. Leaving the money alone and getting used to having it will help you to minimize and even eliminate irresponsible or unsustainable spending as you work through the feelings about and solicitations for your new money.
Step 2: Take Stock of What You Have and Update Your Plan
In behavioral finance, there is a concept called 'mental accounting' that describes the operations used by our brains to organize, evaluate, and track financial activities. Put another way, it has to do with our bias to treat money differently based on various factors, such as its intended use or source. This manifests itself in receiving a windfall because coming into a large sum of cash can create an illusion of endless wealth and, therefore, more easily rationalize excessive spending and making poor financial decisions. As a result, many people squander their windfall because they overestimate how much they really have and what it can do for them.
Once the money has been left alone for six months to a year, then take the time to review or establish your financial planning framework to get an overall picture of your present and make educated estimates about your future. More often than not, the windfall will require you to revisit and revamp certain areas of your financial life, including:
Risk tolerance and asset allocation,
Retirement planning and safe-withdrawal analysis,
Tax planning with regard to amounts owed on the windfall and other potential taxes generated from this money,
Estate planning to ensure the money is cared for if something were to happen to you, and
Insurance policies to protect your sudden increase in wealth.
In addition, now is a good time not just to focus on the quantitative aspects of your plan but the qualitative ones as well. Revisit why money is important to you and what you hope to get out of it. The goal is to better equip you to understand how you want to get the most satisfaction from your money over your lifetime. Some other questions you can ask to stimulate your thinking include: What do you imagine your life would look like if money were no object? Would you still be working, or would you quit your job? How would you spend your time? What keeps you up at night? How do you envision your life in the next year? Five years? Ten years?
Once you ask yourself these questions and decide what your dreams look like, translate them into specific goals with realistic, achievable timeframes. Separate them into short-term (ones you want to complete within the next year), intermediate-term (ones to complete in the next five years), and long-term (ones for the rest). You can refine these goals by prioritizing them in order of highest to least importance.
This gives you a roadmap for your financial plan. From there, you can figure out different strategies and align your spending to make those goals a reality.
Step 3: Seek Professional Guidance
Unless you are well-versed in investment, estate, tax, and insurance planning, odds are you will have a tough time figuring it out on your own. Additionally, while learning about these aspects individually is possible, it can be challenging to see the big picture and how they all fit together. What's more, when you go it alone, you risk making critical mistakes that could cost you.
Enlisting the help of the right professionals is worthwhile and can save you time and headaches. These professionals may include an accountant, estate planning and/or tax attorney, and a fee-only financial advisor. These individuals should be able to help you:
Assess where you are financially,
Calculate potential taxes owed from the windfall,
Review what insurance policies you currently hold and make recommendations for ones you will likely want to purchase or drop,
Create a roadmap for how to proceed with any matters involving settling an estate,
Updating your own estate planning needs, and
Help you create a picture of how the windfall can shape and build on your long-term financial goals.
It is important to remember that you want to seek advice from someone who will put your best interests first. Moreover, it is a good idea to find reputable professionals with experience helping clients with windfalls and those in transitionary periods of their lives. A trusted fee-only, fiduciary financial advisor can provide steadiness when navigating complicated and confusing financial matters. They can also offer insights into common pitfalls and provide guidance on how to avoid them. Check out our blog post, 10 Signs It Is Time to Work with a Financial Advisor, to learn more about what financial advisors actually do, how you can ensure you get quality advice, and what questions you should ask before hiring them.
If you are caught off guard by a financial windfall, remember that you do not need to manage it alone. Successfully handling a windfall requires an appreciation for its emotional and financial aspects. If you need help taking control of a windfall, check us out! You can schedule a complimentary, no-obligation call with us here.
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About the Author
Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and virtually nationwide with the financial decision-making process to organize, grow, and protect your assets.
** This writing is for informational purposes only. The author and Holzberg Wealth Management do not guarantee or otherwise promise any results that may be obtained from using this report. No reader should make any investment decision without first consulting their financial advisor and conducting their own research and due diligence. These commentaries, analyses, opinions, and recommendations represent the personal and subjective views of the author and do not constitute a recommendation, offer, or solicitation to make any securities transaction. The information provided in this report is obtained from sources that the author believes to be reliable. External links to third parties are being provided for informational purposes only. Holzberg Wealth Management is not affiliated with the third-party websites linked to, unless otherwise explicitly stated, and does not constitute an endorsement or approval by Holzberg Wealth Management of any of the third party’s products, services, or opinions.