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:

  1. Pay any taxes due.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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?

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