Successfully Managing A Financial Windfall
We’ve all heard the stories. If not first hand, at least in various news reports and anecdotes.
Some “lucky” person picks the winning numbers, prances before the cameras in what can only be described as a media lovefest, and lives happily ever after, free of financial worries.
OK, the first two points are correct, but the happily ever after doesn’t always materialize. In fact, in most cases, sudden money leaves the winner worse off than prior to their windfall.
Many winners, who aren’t used to managing a large sum of money, mismanage the funds and wreck their lives in the process. As it turns out, it’s a variation on the theme of the Prodigal Son. Only the names and the details change. Of course, odds of winning life-changing cash in a lottery are incredibly low.
We are more likely to be the recipient of an inheritance or an insurance settlement. And it’s the unexpected pile of cash that may create an initial sense of euphoria and a false sense of security.
“The vast majority of people blow through [a financial windfall or inheritance] quickly,” said Jay Zagorsky, an economist and research scientist at The Ohio State University and author of a study on receiving an inheritance.
Whether large or small, it can seem like “play money.” And that is where the danger may lurk. So, that brings us to the next question. What should you do if you happen to be the beneficiary of a financial windfall?
10 steps to creating a firewall around your newfound stash of cash
1. First, do nothing. That’s right, do nothing. The temptation may be to buy a new car, take a luxury cruise, or upgrade your living arrangements. That can begin an unwise cascade of purchases that will likely leave you feeling regret. A suggestion is to wait at least six months before embarking on any life-changing decisions. The time spent waiting and planning allows the “shock” of your newfound wealth to wear off.
Besides, you need to take time to learn exactly what you’ve inherited. Is it all cash? Is it stocks and bonds? Have you just become the owner of a business or real estate?
2. Talk to a trusted advisor. Find someone who has your interests at heart, not his or hers. If you are expecting to receive a windfall or have already received an unexpected inflow of assets, let’s talk and see how we can incorporate it into your overall financial plan.
The suggestions we provide below are basic fundamentals. They may not apply directly to you, but they are common sense tools designed to help you make smart decisions and prevent an expected or unexpected windfall from being squandered.
3. Doing nothing also means not quitting your job. It may be tempting, but lost wages and the lack of social interaction from your coworkers may lead to remorse, even if you don’t especially enjoy your job. Besides, without work, you run the risk of blowing through your money much quicker than you had anticipated.
4. Reduce debt. We’ve always provided a holistic approach to financial planning. Once things have settled down and you have a better understanding of your inheritance, it may be time to pay down or pay off high-interest debt. Once eliminated, you no longer have that onerous outflow of interest payments on your loans.
5. If you don’t have an emergency fund, now is the time. Set aside reserves of at least three to six months' worth of your expenses, preferably the latter. The future can sometimes throw you an unexpected curve ball. Having reserves set aside will reduce your financial stress.
6. Additionally, you may decide to allocate additional funds toward savings and retirement. Again, every one of our clients is unique, with various goals, personal circumstances, and financial resources. What our team recommends for one person may vary significantly from what's best for another.
7. Think about tax and estate planning. No one is sure what may or may not happen to the tax code this year or next. But it’s critical that you get a handle on the tax ramifications of your inheritance in order to maximize the financial benefit.
For example, did you know that you may be required to take distributions if you inherit an IRA? What if you are already taking required mandatory distributions? You see, things can get tricky rapidly, but sound advice can quickly ease any concerns. Additionally, life changes are a great time to update your estate plan, especially if the inheritance increases the complexity of your financial situation.
8. Be cautious. Less-than-reputable salespeople and relatives may suddenly warm up to you, with the unspoken goal of separating you from your cash. That’s why a trusted advisor is critical. If you have a well-thought-out financial plan, it’s much easier to pass on potentially exploitative offers.
9. Consider charitable giving. Do you have a favorite charity? Would you like to help a niece or nephew finance their education? Now is the opportunity to explore the possibility of helping others.
10. Have some fun. There’s nothing wrong with treating yourself. As we provide counsel, we would like to leave some room for self-indulgence. Do you like to travel? Have you thought about an addition to you home, finishing your basement, remodeling your kitchen, or upgrading appliances? Maybe it’s those top-of-the-line golf clubs you’ve been eyeing, or a new car.
Or, maybe you’d like to spend money catching up on the everyday things of life you’ve been putting off. Everyone has a hot button.
With a financial plan in place that manages your windfall, you’ll feel much more secure enjoying the benefits of your wealth without the nagging worries that you might run through your nest egg with not much to show for it.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation
By: MICHAEL HOWELL
I must admit, I hate when others categorize my generation of Millenials with a broad brush. We’re regularly stereotyped as the pampered, lazy, underemployed tech savvy generation that doesn’t understand hard work.
Admittedly, we are rather tech-savvy. I’m certainly not a tech savant, but every time I visit my wonderful grandparents in Southern California, I’m hit up to fix some piece of technology that’s malfunctioned in their home. The wireless printer stopped working. A website doesn’t look right (because the web browser is zoomed in 400x and the images and text are cut off), or they inadvertently changed the home page on their browser and lost their favorite links. The best one though, and I’m willing to bet every Millennial has heard these words more than a few times: “What’s my password again?"
Look, we GET technology! By no means does that make us all computer science experts, but we were the beneficiaries of the Bill Gates/Steve Jobs effort to get the personal computer into the average American household. As for the other stereotypes, we can all recognize there’s a mixed bag of truth and fallacy in them. Fortunately for Millenials, the book isn’t written on us just yet.
It turns out; some Millenials have been financially savvy in their savings habits too. Although student loan debt and high unemployment persists as a significant headwind, a positive economic trend has developed among those Millenials that have managed to find work.
Millenials have begun saving for retirement at a median age of 22 - More than a decade earlier than the Baby Boomers, and five years earlier than Gen Xers. [i]
It would appear many Millenials have in fact been paying attention to what older generations have been telling them! As I reflect on this trend, the figures aren’t altogether surprising.
Most of us were graduating from college or in the early years of our careers during the Great Recession. We witnessed the consequences of an over-leveraged population of Americans burdened by credit card debt and owning homes that were, generally speaking, far larger than household income could support when stress tested. Shrunken retirement portfolios, job loss, and home foreclosures rocked the worlds of people we care about. Moreover, the issues plaguing the Social Security system have caused many Millenials to plan as though they’ll never receive a benefit.
So again, for the few Millenials that have managed to find work, it seems the advice has been followed: Save early, safe often, and live frugally.
I entirely applaud the basic elements of this advice, but I’ve also discovered a missing layer to the story. According to a recent report from UBS Investor Watch, the risk tolerance of Millenials is extremely conservative, with 52% of the average investment portfolio allocated to cash. [ii]
Although Millenials have been excellent savers, I fear the dramatic market volatility we’ve witnessed in recent years has resulted in us being far too timid. This lack of conviction and willingness to take on risk in the markets is certain to have repercussions in later years if this line of thinking isn’t addressed for a number of reasons:
First, it reflects a collective leeriness over investing in stocks.As volatile as stocks can certainly be, continued investment in the growth of successful companies helps drive our economy forward, and stocks have statistically been the best investments over long periods of time.
Second, meaningful stock exposure is most advantageous for any young person, and is in fact necessary to build up a sufficient nest egg for retirement.With advancements in healthcare, Americans are already experiencing 20 to 30 year retirements, and Millenials are expected to live even longer than their predecessors. Millenials need stock exposure to grow their retirement accounts, but best of all they have the luxury of timeto ride the rollercoaster of volatile markets and take advantage of buying opportunities when prices are low.
Last, it exhibits a focus on the “short-term” rather than the “long-term” with respect to saving and investing. It’s a prudent move for all families to establish some liquidity and build up an emergency reserve worth 3 – 6 months’ worth of monthly expenses. This makes it far easier to stomach the ups and downs of market gyrations. However, in retirement and investment accounts, Millenials keeping a significant position in cash at a young age reflects little more than fear of what the market is going to do. Investing on fear is a dangerous recipe, where emotionally charged decisions can lead to financial catastrophe.
So briefly, the following are some simple pieces of financial advice for my fellow Millenials:
Take Advantage of Time
If you haven’t started saving, start now! It’s never too early or too late to get started, but there are substantial investment benefits to starting early.Understand the power of compound interest. Time allows interest to compound on top of itself, and the longer you allow it to compound, the larger the growth of your investment. Begin to develop a long-term mindset with your investments. When markets go down, ask yourself if you’re going to retire in the next few years. If you’re not, the wise but counterintuitive move is likely to open your checkbook and invest more while prices are low.
Continually Invest& Automate the Process
Make it a habit to invest a fixed amount of money every single month and automate the process through your bank. Investing a fixed amount at the same time every months means you’ll invest when the market is high as well as when it’s low. This will lower your average investment costs over time and means you won’t have to worry about getting the timing right on when to invest. Also commit to doing this right after you receive your paycheck. Of course, don’t invest more than your budget can withstand, but you’re more likely to invest more after getting paid than waiting to invest with the leftovers after paying down monthly expenses. Form good investment habits now, and they’ll carry forward with you for the rest of your life.
Diversify, Diversify, Diversify
Diversification is a core investment principle that originates from biblical wisdom, and this advice has stood the test of time.It’s important to understand what you’re investing in. Buying a single, individual stock carries more risk than owning one hundred stocks. Why? Because you can break a single pencil, but you can’t break one-hundred pencils tied together. These days, it really isn’t difficult to diversify by purchasing mutual funds and exchange-traded funds (ETF's), which are generally invested in hundreds of stocks and/or bonds at a given time.
These are just a few simple principles that will move you down the path toward becoming a wise and successful investor.
[i] TransAmerica Center for Retirement Studies (2014). Millenial Workers: An Emerging Generation of Super Savers.
[ii] UBS Investor Watch Report (2014). UBS Investor Watch Report Reveals Millenials are as Financially Conservative as Generation Born During Great Depression.