Ask the Readers: I’m Not Good With Money — How Should I Handle a Windfall?
Friday, 1st February 2008 (by J.D. Roth) Mitch recently wrote to me with one of the toughest reader questions I’ve seen yet. He lives a paycheck-to-paycheck existence, but will soon be coming into a lot of money. He wants to know what he should do:
It is now 11:45pm on 14 January 2008, the day before payday! It’s also about three days before being broke. With no savings and poor credit, I’m living paycheck-to-paycheck. For now, I bring home about $400 a week. I have lived like this for about 15 years, and it is not a good way to live.
Here is my question: In July I will be getting $125,000. What do you think is the best way to make this money last?
I’m really ready to stop living like this, and think that I have a second chance to change things. About seven years ago I received $50,000 and have nothing to show for it today but a few good stories. Thanks for any help.
Wow. There’s so much to respond to here. I’ve been where Mitch is — living paycheck-to-paycheck — but I’ve never experienced a windfall, let alone two of them. I think Mitch is in a unique position, having burned through one windfall before. I admire his desire to escape his current situation, to make the new windfall last.
The Bogleheads’ Guide to Investing has a great chapter on how to manage a windfall successfully. I’ve shared this advice before, but it’s worth repeating. The authors say that if you come into sudden money — through inheritance, the lottery, or any other means — you ought to follow the following steps:
- Pay any taxes due.
- Take one or two percent to treat yourself and your family. If you receive a windfall, by all means do something special. But do it modestly. How much is 1-2%? It’s $10-$20 on a $1,000 windfall. It’s $100-$200 on a $10,000 windfall. It’s $1000-$2000 on a $100,000 windfall.
- Use some or all of the money to pay off debt. As unglamorous as this sounds, it’s the best course of action. If you have existing debt, use your windfall to get rid of it. This will free up cash flow, and you’ll essentially be able to enjoy a prolonged time-release windfall.
- Deposit the rest of the money in a safe account. Put it someplace that will earn you interest while you decide what to do with it.
- Do not touch the money for several months. Allow the initial emotion to pass. Get over the initial urge to spend the money on a big house or a fancy car. Live your life as you had before.
- Make a wish list. Spend time learning how much the windfall can buy. Most people have unrealistic expectations about how much $10,000 or $100,000 or $1,000,000 can buy. Resist all temptations to use the money now, but run the numbers to see what it could buy.
- Get professional help. Do not obtain advice from somebody who might profit from your money, such as a commissioned broker. Find a good CPA who does not sell investment products.
This is good advice, but it’s very much “by the book”. Coping with a windfall, as with most financial decisions, is more about mind than it is about math. There are powerful emotional and psychological factors to be considered. Mitch is living a paycheck-to-paycheck existence and isn’t happy about it. That’s an important consideration here.
What advice do you have for Mitch? Have you ever experienced a large windfall? How did you handle it? What would you do differently? What can he do to preserve his capital while also improving his current quality of life? How can he balance short- and long-term happiness?
This article is about Ask the Readers, Choices, Psychology, Real-Life
After paying off debts I would buy a diversified index of high yielding equities. You could probably get a 5% income from these, resulting is an extra $500 a month gross.
Ideally this money could then be used to fund an IRA or other investment with the additional capital growth of the equities.
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GRS: This is a tough question- can we get a little more information? The things that come to mind…
What’s his education level/age? (Interested in investing in more school?)
Along those lines- Does his employer have a 401k matching program? What’s his general work situation- Does he want to change jobs?
What kind of debt (type and amount) is he looking at? I’m assuming he doesn’t own a house. Any large (and necessary) purchases he sees in the immediate future?
I was in a similar situation and would love to share what I did, but don’t want to sway him if we are in different situations…
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I think the advice to put the money in a savings account and ignore it is spot on. Maybe a short-term CD would be a better option for Mitch.
The other option is to deliberately spend/invest it all. If you haven’t mentally made the step to living within your means then you are likely to fritter the money away. If you spend it deliberatly and sensibly, you will at least have something to show for the money.
Use it to buy a house or pay off the mortgage.
Put as much as possible into untouchable 401(k)/Roth IRAs – buying yourself more of an income in the future.
Keep an emergency fund in a CD.
Replace the car if it’s going to need replacing within the next 2 years.
Do all the repair work that needs doing about the house.
These are all ideas that will need to be funded eventually, and if you’re likely to buy a HDTV rather than get your life in order, it’s better to spend on sensible things, than on fripperies.
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Another good post here.
Preservation of the windfall would be a good idea without any uneccessary spending. Yes, I think preservation is the most important here. When will another opportunity come up like this? For most it’s never. For some only once.
Is living in the now important? Or is future ability to survive important? How can that windfall increase income without using it directly?
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The question I would ask is whether Mitch intends to get serious with financial planning. If so, I would advise him to buy a house or condo (depending on where he lives and what that money will buy) outright, freeing up his current rent payments to save (emergencies) and invest (retirement).
If not, frankly, I would advise that he ask that this money be given to him in a spendthrift trust. Otherwise, he can find a way to get to it whenever temptation strikes–by taking out a HELOC against any home he buys, withdrawing from a retirement account, breaking a CD, etc.
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My wife and I recently received a large sum of money. First we put 20% in an online savings account to distribute to charity as needed. We were already working our way out of debt, but we used part of it to pay off our student loans and HELOC. We fully funded our IRA’s for 2007-08. Currently the remainder is sitting in our online brokerage account waiting to be invested. I will be investing it over time mostly in a Total Market index fund and some in individual stocks.
Without knowing more about Mitch’s situation, it is hard to give advice. But I would say first and foremost get out of debt and have an emergency fund.
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I think we need more information. Is he married? Does his wife work? Does he have children to care for? What is his education level? He mentioned that he has poor credit, does that men he’s in debt? If so, how much?
He really needs to be contacting a reputable financial planner that can help him sort out his goals and his own personal situation. The problem is finding one that won’t drain his money under the guise of helping him.
Until he finds that person, he should probably spend a small amount (less than $5,000) getting himself caught up on late payments and doing something fun. The rest should be put into something that cannot be touched for a certain period of time.
Another problem is that he will suddenly find himself with a lot of new friends who will want to get a piece of the action. Discretion will help him as much as anything in this case.
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You’ve provided sound advice. That $125k could be the best thing to happen in that guy’s life if managed properly. I like your idea to just let it sit for a while, after paying off debts, taxes and paying for a small treat – maybe a reasonable vacation. Too many people rush out and buy a car or upgrade houses and are left with the same monthly bills (or more), and therefore the same paycheck-to-paycheck lifestyle.
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Yes, Adam’s suggestion of further education is a good one – because i think that’s the only way this money might be any form of ‘second chance’. Otherwise, having a chunk of money is not a second chance to change the way you live. *You* change the way you live, not money. I feel like Mitch needs to forget that money for a bit, and instead use the realisation that he’s ready to change the way he lives to start making some of those changes. Then if those changes turn out to be a little costly (like studying for some more qualifications, a business startup, or even moving to an area with the potential for a better paycheck) that money can be invested in a change for the better.
I feel like Mitch’s perspective on these windfalls as a ‘second chance’ is the fundamental problem. They aren’t going to change the way he lives, he’s going to have to do that himself.
Just some thoughts, some of which has already been said above. Think i’d be floundering a bit having gotten a bunch of money like that too (after paying off debts of course), and would be pleased to put it in a savings account and forget it for a few months while i mulled over plans!
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First, pay off all debts (except mortgage if applicable). Then, put it all in a CD for about 9 months. Yes, you may or may not be getting as high of an interest rate; but it is imperative that you put it somewhere where you won’t be allowed to touch it for awhile.
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I’d love to know how much debt Mitch has – because if it’s not a huge amount, he should definitely pay it all off right away. Also you’re right to advise him to put it in a savings account straight away and wait a while – if he spends a lot right away he may regret it. I think it depends on the person as to what the best plan would be. Personally I’d buy a few things but keep most of it to use to start up my own business when I finish university.
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1) Pay off debts
2) Invest the remainder in something safe for now
3) Maybe use it to increase your income: to generate investment income or, if you’re young and motivated, to go to college. A degree that is in demand will improve your odds to get a high salary.
4) Maybe use it to lower your expenses: if you don’t own a house, you could wait for housing prices to drop extremely low, then buy the cheapest smallest house you can be happy in (no more rent means less fixed expenses, at least if it’s not a high-maintenance house)
Congrats on thinking about what you’re going to do. That alone improves your odds for a nicer future.
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In this case I would skip #6 :make a wish list: as his goal is to change his life with this windfall. As Camilla says, the only thing that will change your life is you. You could spend that money on education, job training, stocks or fun, but the change won’t happen unless you work to make it so.
So to that end, I would recommend spending a portion of that on a life-coach who can provide some aptitude testing and goal setting advice on where you want to be 5-10 years from now and how to get there.
One of the areas the life-coach will help you examine is what life improvements you want to make that will have long lasting effects on your income potential. In no particular order these are Education, Job Training, Owning a Business, and moving to a location where your current skills are more in demand/where pay is better comparable to cost of living. You might end up with a combination of the above.
The other thing I recommend is building up your network of supporters. A life-coach is a good step in that direction. But most business success stories are built with the support of key members in the community. Join two or three local social networking organizations (The Elks, Shriners, Chamber Of Commerce sub groups, technology clubs, etc) and get to know the people who share similar interests and who have already established their success. You’ll find they’re very willing to share tips, tricks, and how-to’s when it comes to improving your lot in life.
Most of all Good Luck. As some one once said, Luck comes to those who plan for it.
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I agree with J.D.; it is really a question of mindset. If you go in without planning, thinking, and *convincing yourself* about how you want to use the new windfall, it will likely go the same way as the earlier one. So step one could be to figure out what the best course of action is, and then step two is to believe it – convince yourself.
So think about it. What’s worth more to you? $125k of stuff and experiences now, followed by more of the same, or $125k of security for as long as you keep it? Some mix of the two? You are living on your income now, so you could keep doing that, living paycheck-to-paycheck in a sense, but with the security of money in the bank. If your concern with your current situation is just the problem of nearly going broke each pay period, then this could work. If you’re upset with your current standard of living, then you can use the money in other ways. But in any case, figure it out before you have the money, and *believe* it. “I should save it” is much different than “I will save it,” for example.
After that, the details aren’t as important. Put it all in the bank, invest it and spend the income, draw it down over time – whatever it is, decide beforehand. Others can give you lots of ideas on how to use it.
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I now work in the investment industry but some years ago I was living paycheque to paycheque (on part-time income) until I started reading about personal finance, applied the lessons to my life, and eventually made it a career. The suggestions given were good and hopefully this person would have the discipline to follow. I’d endorse the recommendation to not touch it for several months–lock it into a CD; bite the bullet and refuse all requests from friends & relatives–many will become quite friendly to you and incredibly rude when declined so be ready for it. If you must buy something let it be an appreciating asset like a house or portfolio and not a car, boat, recreational vehicles etc. or vacations. Let the money work for you: be patient and let the money generate interest or dividends or capital gains and then use *that* money to buy the fun stuff. He needs to have something to live on in retirement.
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The suggestion to find a professional CPA is make sure they have your best interest in mind and ask this question. What is 1+1? and if they answer “2″ then move on to the next CPA the answer you want is “What would you like it to be”?
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Following the “advice” of others is following the “path” of others — and that path is almost always wrong. The comments asking for more information are wise…
Essentially, Mitch needs help finding his path. Personally, I suggest enlisting the help of a “fee-only” financial advisor with at least 10 years experience and a Certified Financial Planner (CFP) designtation. Fee-only advisors do not get paid by commissions (removing bias to certain products) and CFP’s have a good knowledge of the six basic financial areas (investments, insurance, retirement, taxes, cash flow, estate planning).
Before enlisting the “fee-only” CFP, Mitch may also consider hiring some kind of “life coach” or career counselor.
The most prudent financial decisions begin WITHOUT the consideration of money.
Another person named Mitch said this: “Life is not about making money — money is about making a life.” ~ Mitch Anthony
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Great suggestions. Add on there, use a portion of the remaining funds (hopefully there are some with that large of a windfall) and better your job situation. This may involve education or training, or perhaps having the time to take off a little work to (actually) shop the job market.
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How about:
1). Pay off Debt
2). Expand your education so you can get a better job.
3). Invest the remaining balance and don’t touch it.
The money should not be spent on anything besides those three things (except for the 1-2k recommended for having fun).
A windfall is not going to change your life, changing your habits and behaviors is going to change your life. This is why the education is important; and then make it a goal to increase your annual income rather than using the windfall to “help” you.
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Here’s what I’d do, based on the assumptions I made listed at the end.
1. Put $8,000 in a money market mutual fund (This represents 20 weeks of income for Mitch as an emergency fund, if he plans to leave his job for another, I’d increase that to $12,000)
2. Spend a little. Mitch doesn’t need to spend 1-2% to enjoy his windfall. Since he is living paycheck to paycheck, even a purchase of a few hundred dollars would be a nice reward. I’d recommend spending $500 and setting aside another $500 to spend in 3-6 months.
3. Pay off all debts. Mitch doesn’t mention what he spends his $1,600 monthly income on, so this is a real wild card. Getting rid of debt payments will allow him to have extra money every month, something he hasn’t had for 15 years. This would definitely improve his quality of life.
4. Invest $5,000-10,000 for future goals such as buying a house, taking an annual trip, or education for a new job.
5. Invest for retirement. Amount depends greatly on how much money is needed to pay off debts.
If Mitch would like, I can perform a free financial plan based solely on his situation. I am offering this to all of my readers free of charge with no strings attached. If you’re reading this Mitch, click this link if you are interested: http://moneymyths.org/blog/2008/01/28/free-financial-planning-help/
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In the beginning of 2001 I received about $400,000 (after tax!) from the sale of a company that I co-owned. A stock broker friend of mine urged me to put it all in the market because stocks were so cheap at the time (so he thought). I followed his advice, but of course the market kept going down and down. Within a few months my $400K was down to about $150K (it went as low as $80K post 911), some of the stocks became worthless (e.g. worldcom) and most of that loss would never be recoverable due to the insanely high price I paid for those stocks. I’ve since taken over my portfolio and have brought it up about 50%, so things are getting back on the right track, but the biggest lesson I learned is what I should have done with that money…
I had all that money at one point and didn’t pay off ANY debt. I didn’t have CC debt, but I did have $20K in student loans at 8% and I had $20K that I owed for car (9.5% rate). Why didn’t I pay off the debt? I thought I could make more in the market, especially since stocks were so “cheap” relative to their dot-com highs. Yet while I was losing money in the market, I ALWAYS had to fork over the same hefty payments each month to pay off debt. Eventually I realized how stupid I was and I sold off some stock (at great loss) to pay down the debt. I now have zero debt aside from my mortgage and it’s a great feeling.
So… pay debt first!
Also, I totally agree with enjoying some of the money and letting the rest sit around in a no-risk investment for a while. I never did anything fun with that money. Nothing at all. I just watched it disappear while filled with terrible anguish.
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Since you’re bringing home $1600 a month, you need to get some job training that will open up new opportunities for you. Go back to school.
Instead of spending the money on this venture, invest it in a fairly safe, no-load instrument that will return something, and take out student loans to go back to school. Use the proceeds from the investments (not the principal) to help cover your living expenses. With the enhanced earning power you’ll get from more training, you probably will be able to pay off the loans out of your new salary, preserving the principal as the basis for retirement savings.
If you can get yourself into a university, go for one of the vocationy majors such as accountancy or nursing. If you can’t get into for a four-year school, head for the nearest community college and score an associate of arts in a field that will qualify you for better-paying work. If you have a learning disability, such as dyslexia, most community colleges & universities have learning centers where you can get one-on-one help with your studies; also, if you identify yourself to the Disability Resources Center (strictly optional), the school is required to provide you with resources to help you get through your coursework.
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I have a friend who received only $5k – but the contrast between her and her sibs who inherited the same amount was remarkable.
Here’s the story:
http://moneychangesthings.blogspot.com/2007/10/true-tale-making-lemonade-out-of-lemon_28.html With $125K a person could accomplish a complete turn-around. Provided the person can develop self-discipline too…. He/she just can’t be thinking they’re rich. $125K doesn’t go very far if you’re living a lavish life.
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There are lots of good suggestions here and following any of them would likely make Mitch less likely to blow through is windfall.
I like plonkee’s suggestion of buying a house (or condo). I’d add that Mitch should consider buying the smallest and lest expensive house he can afford. That may not be the most popular option for the average American given the huge increase in the average home size in the last 20 years, but it’s hard (not impossible) to spend a house.
Then Mitch can take what he normally spends in rent today and put most of it into savings, allowing him to build the habit of saving. Month to month he may not have more cash on hand, but he’s now in charge of building his next large windfall.
Mitch, if you read this I hope you’ll let us all know what you decide to do when the time comes.
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Consider the long term & short term. I have to agree with the poster who said to replace his car if he is facing needing to replace it soon. However, this should be a *practical* choice, not a sporty or “cool” choice. If he *needs* a car for work (or school), I’d advise researching cars carefully for longevity, fuel economy, and expense of maintenance.
I had a friend in college who was *always* broke. She needed a car to work and go to school, and, she always bought the cheapest, POS car she could because she could never save up any money. This became a cycle of replacing the car with ANOTHER POS every six months. Another friend bought a NEW sporty german car not too long before he lost his job. He racked up debt after losing his job & while still trying to climb out of it *years* later regretted the car because it had a number of problems & the parts & repairs were very expensive.
While a car’s physical value depreciates, the value of reliable transportation can be huge. It means not missing work or class because you just couldn’t get there. It means not throwing money out the window every month for an “emergency” car expense. In my mind, this could be both practical and “treat”. Something like a Honda Civic isn’t glamorous, but, they run forever, get good mileage & shouldn’t cost a fortune to maintain. This is why I chose a Civic as my first new car — I *could* have afforded higher payments at the time. However, I wanted a practical car and I knew I would be cutting my income by going back to school. This isn’t about getting your dream car — it’s about getting stability.
As for the rest, it’s hard to say exactly. If you pay off your debt, will you move your debt payment into funding your retirement? How *old* are you? (Not that you *have* to answer that question.) Someone who is in their late-fourties may rather fund their retirement than go back to school. If you’re going to consider going back to school, what would you major in? Going back to school to major in English lit or Classics is not that practical if the goal of the education is to quickly get you out of your situation. If you’re interested in math, accounting could be a good and stable choice. If you’re interested in working with people & medicine, I’d recommend nursing. (There’s a nursing shortage & their pay rates are improving — get a BS & your RN and you’d do well.)
All in all, I’d recommend locking it up in a CD while you research and figure out what you want to do with your life. Research careers, cars (if you need one), debt management. Figure out what you really *need* in the short-term to do well in the long term, whether that’s shedding debt or getting a degree.
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The Financial Philosopher said:
“Following the ‘advice’ of others is following the ‘path’ of others – and that path is almost always wrong. The comments asking for more information are wise.”
I thought that was great and worth repeating.
On step #7, “Get Professional Help,” CPAs are not necessarily required to always advise in their client’s best interests. It is important that any professional’s written service agreement clearly spells out the obligation to, at all times, place your best interests before their own without exception.
I’d also be cautious of those offering a free financial plan. Developing a meaningful financial plan for someone else takes a fair amount of real work (and responsibility) to do it right. I cannot imagine anyone doing this for free for anyone who wants it. Sometimes, even when there are no strings attached, the plan calls for action that (coincidentally?) involves additional services or products for a fee from the author of the plan.
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It sounds like Mitch has the T-shirt for blowing a windfall, and wants to build on the new one.
I agree with a lot of the pps, specifically:
– #5 of JD’s column: “park it and wait” (I would almost do this before paying off debt, depending on the debts involved). You have a lot of homework to do; be more afraid of wasting or losing your windfall, than of missing an opportunity RIGHT NOW.
– Think about what you want your life to look like (“the big picture”) going forward. Think outside the box; this is a good time to think creatively. (DH and I do this when buy our annual lottery ticket and imagine having extra $Ms, and what we’d change. It’s startling how many of these changes we’ve done anyway, even without the millions.)
– $125,000 probably looks enormous if you’re living on the edge at $1600/month. It gives you a lot of additional opportunities (move, school, home, travel, nest egg, health improvement costs, small business starter money, etc.), but it isn’t as though you’ll never need to work for pay again. I agree with that part of the “wish list” idea — you need to get some perspective of what this money can do, and what it can’t.
Good luck! It’s one of the nicer problems to have!
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The posters all have some very good advice. A fee or by the hour advisor who can talk to him about his goals and choices would be money worth spending. The important thing to do, once paid taxes, paid off debt, created an emergency savings account, is to somehow lock up the money so it is not so easy to get to. As he has learned from past experience it is easy to go through “found” money easily if one does not have a plan. Unlike others I think he could have a little more than 1-2% for personal use, more like 5% in an account for expenditures, otherwise I can imagine he may feel deprived and spend even more money. Personally whenever my husband and I get a windfall we spend around 10% on ourselves, rest into savings.
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All great comments here. But until financial habits have been examined in the most honest way possible, as the very first step, it is probable that they will continue. Changing one’s life habits, in many of the ways suggested in this forum before, may be what is actually needed. Perhaps, do nothing with the monies until a clear examination of those habits has taken place.
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Stories about lottery winners becoming poor again are common. The problem is the unconscious idea that a large some of money is inexhaustible or will not be whittled down fast with “just this one expense”.
Mitch should tell himself once a day that money will easily be gone and on things he values little if he is not vigilant.
Then follow those steps.
Yes, he hates living low, but he will be right back there, permanently once that money is gone if he pisses it away.
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Personally I would pay off any high interest debts (taxes, credit cards, anything charging you over 6% that isn’t a mortgage). Then I’d put the rest in CDs until I got some advice – either from a professional or preferably through self-education. If you don’t educate yourself the professional is going to get a chunk of your money because you didn’t prepare well. This may take up to a year, but its time well spent – get to your library and get some books to help advise you – JD has a good list of books that might help. http://www.getrichslowly.org/blog/2007/03/07/building-a-personal-finance-library-25-of-the-best-books-about-money/
You should be able to live off your pay, especially if you’ve taken care of your debts, while you are trying to figure out what to do with this money. $125k isn’t going to give you a lifetime of security instantly, but it can help you achieve that status over time. Good luck!
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I feel like I’ve been in a similar situation to Mitch- living paycheck to paycheck with horrible credit. I am very familiar with scraping change up as I wait for the next paycheck to come. It’s stressful and it sucks. I’m getting out of that, due to increasing my income and breaking bad habits, finally.
If I were to recieve the windfall, here is what I would do:
1. Analyze. What is causing you to live paycheck to paycheck? Low income, high expenses. What is keeping your expenses high? How can you change this? Dig deep. If the answer is ‘debt’ think about why you got into debt and how you can change those behaviors. If the answer is ‘eating out’ (even if it’s just fast food- it adds up) ask yourself why you do so, and what you need to enable your success with cooking. If the answer is ‘past medical expenses’ what can you do to reduce any health problems in the future? Do you have health insurance? Can you get more frequent check-ups to prevent problems from mushrooming?
The best time to do this is now, since you aren’t getting the money for a few months. Like others have posted, you have to work on changing yourself if you want your situation to improve.
2. Emergency fund. I would establish this straight away. Living paycheck to paycheck any unexpected expense can completely screw you. I would set it up with 1 to 2 months in a high interest savings account and the balance (4-5 months) in a monthly CD ladder. This way, there is always some money coming available for an extended emergency but you don’t have access to everything at once.
3. Reducing monthly expenses- Hopefully you have thought of what is causing you to spend most of your income by now and formulated a plan.Are there payments that can be reduced or eliminated? Debt is the big one here, of course. Paying off debts will save you the interest income and free up some room in your monthly budget. Are you renting something you can purchase outright for savings in the long term? Do you eat out too much because your kitchen is understocked? Purchase some inexpensive but reliable kitchen basics (emphasis on basics, not fancy items) that enable you to eat at home or bring your leftovers to work for lunch. Is your area too expensive with too high rent? Use a small bit of the money to pay for a deposit at a cheaper location.
3. Increasing Income- Look into education, as others have posted. Can you start your own business with a small amount of capital? I wouldn’t recommend spending all the windfall this way, but it may help get the ball rolling on a side business. Do you need interviewing clothes to get a new job? There was a period of time where I literally didn’t own any clothes nice enough to interview in. This locked me out of many opportunities. These clothes don’t have to be expensive (or even new) but a good outfit or two can really help while trying to find a new position.
4. Fun- I would take 1 (as suggested by the book) and plan something fun, a vacation comes to mind. It will bolster yuor spirits without blowing your windfall.
5. Essentials- Living paycheck to paycheck, is there something you could use that you have been living without? I’m talking basics here: A couch,a dining room table, a few new peices of clothing. You can pick up a couple cheap things that will improve your standard of living if you don’t already have them. The key here is to get these things last, and focus only on the things you really, honestly need. Don’t get carried away! Plan in advance, and set a limit. 2%, maybe.
6. Investments- Hopefully, a good chunk will be left over to jump start retirement savings. I would use whatever was leftover to do so. If there was more than enough to max out an IRA/ roth IRA, set some savings aside for long term goals.
The most important point is this: Don’t wait until you get the windfall to start making changes in your habits. It’s easy to say “when I get more money I’ll change” but waiting is only hurting you. If you set up good habits now, you’ll be more likely to spend/use that windfall in a responsible way.
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I’d skip the life coach, advisor, etc, because good information is available for free.
I’d also hold off on the house – just because you have the money doesn’t mean you should spend it. There’s a lot more that goes into home purchase than money.
I like the original list –
1. pay taxes
2. pay off debt
3. have a little fun (1% is a good guideline).
I’d then add:
4. put 1-2K in a accessible savings account for emergencies
5. put the rest in a CD for 6-9 months
6. spend some time perusing PF blogs to get an idea of what money management really means
7. ask for advice (free advice)
8. track expenses for a few months to see where you’re at
9. develop a budget
10. develop a plan. where do you expect to see yourself in 5 years? how will this windfall help you get there? what else will you need to do to get there?
by this point, the CD will mature, and you’ll have a better idea of what you’re going to do with it. you can also assess the stickiness of your resolution to change your life by seeing what happened to the emergency fund. did you fritter it away? did you use it for TRUE emergencies?
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I’d also like to add – instead of making a wishlist of where you’d like the money to go, think in broader terms of where you’d like your life to go. money isn’t the object, it’s only a tool. and you’ll need more than money to get where you’d like to be.
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Everyone keeps recommending he “invest” the money, or “put it in high yielding” things. If Mitch does not have expertise or isn’t willing to learn how to properly invest/diversify/minimize taxes on his own, the fact of the matter is he’ll have to pay someone for help. Mitch – this is OKAY! I don’t know a thing about installing heating and cooling systems, so I payed professionals a good bit of money to do it for me. Summarily eliminating “commissioned” brokers with one sentence by saying they don’t have your best interests at heart is also wrong.
What Mitch should do re: investing the money is SHOP AROUND. Ask friends for a recommendation of a professional (but not how they invest – you might wind up in penny stocks!) Go to several different brokers (fee and commission based) and get a feel for a few different things. First, what do they want to do with Mitch’s money based on his situation? They should all more or less be recommending similar strategies for growing/preserving capital, minimizing taxes, planning estates, etc. Then, ask the broker how he gets paid. A reputable broker in either category will not hesitate to tell you. Then, how do you feel about the broker? Does he seem like someone you could call anytime? Is he local, or do you have to dial an 800 number to get help? I cannot tell you how invaluable a local broker with time to visit can be to you.
Since we don’t know his entire situation, it’s hard to recommend concrete advice. Paying non-mortgage debts, enjoying a bit of the windfall with your family, and taking your time to decide how and with whom to invest the rest of the money is probably the best idea.
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I wish I would have asked the same question a few years ago when my dad died and I received my portion of his insurance money. I did put some towards our mortgage and put some in savings but most went to my perceived “needs” list (it was really my want list — new vehicle, siding on the house, new television, garden shed, boat, etc.) Had I saved the money and invested it, I could have never touched the principle and still purchased the things I “wanted” over time using only the interest. Now, all I have is older stuff and lots of regret.
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I have two thoughts on this. I haven’t read all the comments (who has time to, really?) so I hope I’m not repeating what others have said.
First, I remember when I was a kid I was asking my family what they would buy if they won a bunch of money. Most people had something from a fantasy, like a new car, or trip. My mom said a maid service. What really threw me for a loop was my dad’s answer. He said a CD. He was looking at it as a way to buy his retirement early, so he could start living his life without that financial storm cloud following him around.
Second, make sure you look at any purchase from far after the purchase. That’s a confusing way to say it. Here’s an example. When I bought my car, I was trying to decide between a used car or a new one. I tried to look at how I would feel about the purchase in two years. With a new car, I imagine I would owe more money than the car was worth, and the car would still be the car that I’ve owned for two years, so I think the excitement would have left. In a used civic, I would know that I made a lot more money by paying cash, and the car might be in poor shape, but at least I knew it didn’t cost me much. If you are thinking about buying a trip to Europe, remember that you will still have to work 40+ hours a week when you get back, and you won’t have anything to show for it. With $125,000 what are you going to enjoy more in five years? $150,000 or memories of $125,000 worth of stuff that depreciated to valueless?
Education would be a good place to start to think about a good place for the money.
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Ditto Financial Philosopher.
A CPA is a good idea, but their experience is limited to taxes and accounting. A life coach is a good idea, but an ethical one does not give financial advice.
A “fee-only financial planner” is able to provide more objective advice than other financial professionals. The fee you might expect to pay is usually covered by the savings from unnecessarily commissioned products and haphazard advice.
They are sometimes hard to find, but find a few to interview to help you use your windfall with prudence.
Please note: I’m an insurance guy who works with a fee-based investor. Neither of us are fee-only financial planners.
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For me unless you get into earth-changing amounts, it is simple…Continue to work your Success Map, or Baby Step…or whatever your plan is.
All of those lottery winners that go broke, because the don’t plan and believe money is infinite…actually it is for anyone, including a Bill Gate, very finite.
Sounds cheesy, but true..
Failure to plan is a plan to fail.
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I’m in a fairly similar situation to Mitch, as I’m expecting a windfall in March. Mine’s all of $1400, though, but that’s about equal to my take-home for a month as a temp (and before you ask, I have a Master’s Degree, think about that next time your local school district comes up with a bond measure).
I’ve been seriously looking at my financial situation for all of two months, and I’ve already set baby-step goals. In the case of my wee windfall, I’m dividing it as so:
- $100 to charity
- $100 to my vacation fund
- $150 to my emergency fund
- $1000 to murdering my credit card debt in cold blood.
- the remainder to my Sonic Screwdriver Fund (i.e. things I want, most recently this fund purchased a NaNoWriMo coffee mug)
However, this is my planning after I’ve sat down and set goals for myself. Being a n00b to financial planning, my goals are simple: build emergency fund, murder credit card debt, go on a vacay to somewhere nice and tropical during Oregon’s disgustingly moist and frigid winter.
I have long-term goals (in 15 years, I will have murdered my obscene student loan debt) and mid-range goals (in 3 years, I will begin investing in the stock market). These goals are in the long- and mid-term brackets because that’s how long I think it will take me to earn/save the money to complete them. Any windfall above what I need for short-term goals will be applied to the further-out goals.
But see, the difference between Mitch and I, even at my whole two-three months of financial literacy, is that I have identified my goals, and begun plans to reach them.
So number one on Mitch’s agenda, I believe, should be to sit down and figure out where you want to be financially in 1, 5, 10, 20, and 50 years.
Just my hard-earned $0.02.
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JD said, ‘This is good advice, but it’s very much “by the book”.’
Absolutely, and this is similar advice that Dave Ramsey gives as well. There’s a reason why he says his advice is really just common sense: It is!
I agree with the advice given there, for what its worth.
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I’m a CFP and I tend to agree with the comments made by the Financial Philosopher in point #17.
There are a lot of suggestions being thrown around here about what you should do; you need something more concrete IMHO.
The advice I would give you is to find someone you can trust, the qualifications needed (pointed out in point#17) are an excellent starting point.
There are plenty of honest, capable advisors that would be willing to help you. I would also get second opinions for those around you that you can trust.
With that said, the first thing you need to do (which hasn’t been mentioned much here) is sit down (with an advisor) and COMPLETE A FINANCIAL PLAN.
Spend some time beforehand preparing for it mentally and picturing what you want your life to be like in the future. (the idea of a few sessions with a life coach is probably a good idea here, good financial advisors are just that, btw)
List what’s most important to you, prioritize these lifetime goals and then plug in the $125,000 and see the feasibility of it vs your goals. Like others said here, more information is needed, but that’s all brought to the table during the planning process.
From there begin the tweaking process. Let’s create a hypothetical list of your top 3 goals:
1- Maintain an elevated lifestyle, from the one you have now, let’s say $600-650 a week
2- Look into covering disability issues, if something were to happen to you on the job (your only real source of income), you need to examine that
3- I’m going to make a few assumptions based on what you wrote (working 15 years) that you’re probably close to 40, if not in your early 40′s.
Goal #3: Create a retirement lifestyle comparable to a comfortable pre-retirement lifestyle (let’s say maybe $600 a week in future dollars)
Ok now we have goals, a starting point. From here we can plug in the numbers and see where we are at. Probably quite a bit of work to be done, would be my guess.
But at least we have the information in front of us, have set our goals and can start thinking about implementing strategies to get you there.
Your investment portfolio should be derived from what’s important to you in life (your stated goals), your attitude towards risk, and what it’s going to take to get you there, not the other way around.
Which is where most people make the mistake… they invest w/o knowing what they’re trying to accomplish, generally looking for absolute returns, opening themselves up for more risk than probably was ever necessary.
Back to you Mitch… now you have a few thing going on for you:
a plan in place
know what you want to accomplish
hopefully working with someone you trust (I’d suggest fee only planner or fee based, like Fin. philosopher said) that can help you throughout the process
Psychologically you should start feeling better about your situation, at this point, as you’re learning about yourself, becoming informed, which will lead to better decisions on your part.
From there you can decide what type of return may be needed to get you on the path to living your goals.
I do agree that wiping away your debt is something you would need to address first and foremost.
Anyway, I wish you the best of luck and you can always stop by my blog, I’d be more than happy to help you some more.
All the best
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I am a financial planner. And I understand the dangers of a windfall.
First off kudos to the reader for stopping the destructive pattern he has been living it. That’s a very hard first step and he deserves props. You don’t have to be living paycheck to paycheck to get in trouble when you catch a bunch of money. It’s in our nature to suddenly think we need to live like we are rich.
Every financial planner is probably going to tell you about the same thing, so allow me to save you $1000.
$125k isn’t enough to be set for life, but it’s a good kick start down the right path.
1% celebration is a good idea, but that’s a lot of celebration. For $5000 you can take a family of 4 to Disneyland for a week.
1. Taxes maybe. Depending on where the money is coming from it may be tax free, like life insurance, or highly taxed, like lotto winnings. Take this seriously, and find out up front.
2. Pay off debt, if you have any. The average in America is around $20,000. If you pay that off you free up monthly cash flow. If it takes it all, I would still pay it off. It’s easier to stay debt free than get debt free.
3. Put the rest in a savings account and don’t touch it for two months. Pick a bank on the other end of town, or in a different state. Don’t get an atm card.
3. Over those two months. Sit down with several financial planners, at least 4. Fee based could be better, but the fees are high. (trust me, I charge them) you might do well with a Funds under management charge. They will all talk to you for free to start. Find one you trust. Then make a life plan (budget, savings, investing and all) and go with it.
Treat this money as a key to a new life. It can open the door, but you have to walk through and follow the path.
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Point: Not a “financial advisor” or “advisor” who will generally sell you a bundle of funds without the experience needed to talk with you intelligently about your mortgage, taxes, risks, etc. A “fee-only financial planner”.
I recently did a marketing study in my area, and it was scary how similar the answers were between financial planners who were not “fee-only” and investment managers. “Fee-only financial planners” seem to have a decidedly different world view.
They sound like synonyms, but they are not.
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This may sound crazy but DON’T PAY OFF ANY DEBT.
It sounds like this person has some problems managing money and I guarantee that if he just pays off his current debts, he’ll rack them up again in the next 10 years because he’ll still be at the same level of maturity (finances-wise) as he is currently.
Continue paying your debts as if you didn’t have the money, because that will help teach you to avoid debt. Invest the money 100% (after paying taxes) with a decent balanced portfolio such as 25% bonds 75% stocks.
To get out of debt is not the goal, that is a side effect of changing the way you handle money. $125k is not enough money to forgo those lessons and live a long and easy life, just like $50k wasn’t enough. You have to win a large lottery for that kind of cushion, and even then some people will end up wasting it all.
As a compromise, I suggest that you set a goal of paying off 50% of your debt without using a dime of this new money. Once you’ve achieved that, take some of this money and pay off the rest of your debt.
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There seems to be a lot of great advice in these comments.
I’d be very interested in a follow-up post to see how this chap is doing. What was his situation in more detail? What did he end up doing with the windfall?
I look forward to finding out!
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I agree with Jon, “Don’t pay off any debt”.
The key for me was to use 0% of this money on myself and save it in an account that I wouldn’t use for spending. Immediately deposit the money into something like a Vanguard money market fund (just open the account online, no cost).
The reason for this is that the money is enough that you will very quickly learn the benefits of compound interest and it’s affect on your life. Perhaps more important, you will start seeing yourself as capable of “being good” at your finances rather than being out of control. This will in turn help you make the right decisions about your income. Small steps like paying off your debt out of your income will be easier. Overall you will feel in control of your life and your money when you have savings of this amount.
The other reason for not using it for debt, is just as other readers have pointed out: You won’t learn to control spending if you don’t learn to pay for it out of your paychecks.
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I don’t comment very often (if at all), but thought I’d throw in a few suggestions. I’m assuming that since Mitch has lived paycheck-to-paycheck for 15 years and is unhappy with how he used his previous windfall, that he’s just starting to learn good personal finance habits.
. One easy way of doing this is to blame your CPA (even if you don’t have one yet), ie: “I’ll ask my CPA about that.” followed by a “my CPA says I shouldn’t do that, sorry.”
1) Definitely stick the money somewhere for a month or two. I’d strongly recommend opening a new account with ING since that’s an easy one to use.
2) Since switching to being frugal and getting a savings mindset is very hard emotionally, do keep a small amount for just pure fun money — but make sure you decide the amount *before* you get the windfall!
3) If you’re having trouble finding a good CPA, try seeing if Dave Ramsey has an endorsed CPA in your area. URL is http://www.daveramsey.com/sa/home/ — this isn’t the greatest way of getting a CPA (I prefer personal recommendations), but it’s a good start.
4) As others have said, practice saying “no” — you’ll have a lot of friends pretty soon
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I think you missed one very obvious use for some of this money: invest in education. If you’re living paycheck to paychek it’s pretty unlikely you’re in a fulfilling career with specialized training. Investing even $10k of that money into a two-year AA degree and then trasnfering to a state school would likely pay for itself in salary the first year out of the gate. Even a trade school or career certification (EMT, nursing, many IT in the IT field, etc) could yield a lasting salary boost that would permanently relieve the month to month existence AND make saving easier in the future. Even better, the vast majority of the windfall can STILL be invested and earning interest in the interim.
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As others have said, we’d need more details of Mitch’s situation to give better advice than has already been provided. Also, Mitch has to be honest with himself about where the original windfall went, where the money was spent, and on what, if he’s to avoid walking the same path twice.
One thing I would be careful of if I were in Mitch’s situation is letting people, even friends and family, know I had or was going to receive the money. I know from watching another friend get a windfall (lottery) that suddenly people around him started to:
1. Try to get him to spend the money on the moment for fun things they wanted to do (e.g. hey, how about you rent a cabin and we’ll all go up for the weekend. We’ll bring the beer and food).
2. Complain every time he said he didn’t want to buy something, go somewhere, or eat out somewhere, regardless of the reason, with words to the affect of “what? don’t tell me you can’t afford it!”
At first they seemed to be expressing their wishes (man, if I had that money I’d do this) and didn’t mean it in spiteful way (and there’s no saying you couldn’t do a few things with your friends and for them). But the attitudes change the first time they ask for money and you say no. Now you’re stingy, a miser, no fun anymore, if “I” had the money “I’d” help you out, etc. It can get ugly pretty fast, and the closer they are to you, the uglier it can get. If you’ve got real, good, friends and family, let them know up front you don’t plan on pissing it away and that you’re looking towards your future. But don’t be surprised if they keep bringing it up.
People also have a tendency to pull folks back to their level of comfort. You’re windfall threatens what they’re comfortable with in you, especially if you try to use it to advance yourself out of their comfort level. I’ve watched my brother-in-laws give my one BIL years of verbal grief for getting a college degree, since none of them have one. He worked days and went to school when he could afford it, and after ten years got a degree and with it, a job paying more than any of them make, which finally shut them up. But I’ll never forget their constant need to try to tear at him to bring him back to their level, where they were comfortable.
Beyond the actual money handling, these can be the biggest problem with a windfall in my opinion.
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