When my father died in 1995, he left behind a small life insurance policy that awarded each family member $5,000. It wasn't much, but it was the best he could do based on the fact that he had cancer. He hadn't been much of a planner, and hadn't been good with money, so that $5,000 per person was actually a significant amount.
At the time, I was deep in debt. I had over $20,000 in credit card balances, and was gradually adding more all of the time. If I'd been smart, I would have taken the proceeds from my father's life insurance and used them to immediately repay $5,000 in debt. But I wasn't smart.
I used $1,000 to pay off debt (and patted myself on the back for it), but spent the rest on a new computer, software, and accessories. It didn't take long to realize that this was a dumb decision.
You see, when you receive a windfall, whether it's a tax refund, an inheritance, a gift, or from any other source, it's like you've been given a second chance. Although you may have made money mistakes in the past, you now have a chance to fix those mistakes (or some of them, anyhow) and start down the path of smart money management.
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It can be tempting (as I well know) to spend your windfall on toys, trips, and other things that you “deserve,” but doing so will leave you in the same place you were before you received the windfall. And if that place was chained to debt, you'll be just as unhappy as you've always been.
Since my father died, I've received a few other small windfalls (and a very large windfall when I sold Get Rich Slowly). With time, I've developed a system for handling these situations.
If you receive a chunk of cash, I recommend that you:
- Keep 5 percent to treat yourself and your family. Let's be realistic. If you receive $1,000 or $10,000 or $100,000 unexpectedly, you're going to want to spend some of it. No problem. But don't spend all of it. I used to recommend spending 1 percent of a windfall on yourself, but from talking to people, that's not enough. Now I suggest spending 5 percent on fun. That means $50 of a $1,000 windfall, $500 of a $10,000 windfall, or $5,000 of a $100,000 windfall. Don't be tempted to spend more!
- Pay any taxes due. Depending on the source of your money, you might owe taxes on it at the end of the year. If you forget this fact and spend the money, you can end up in a bind when the taxes come due. Consult a tax professional. If needed, set aside enough to pay your taxes before you do anything else.
- Pay off debt. Doing so will generally provide the greatest possible return on your investment (a 20 percent return if your credit cards charge you 20 percent). It'll also free up cash flow; if you pay off a card with a $50 minimum monthly payment, that's $50 extra you'll have available each month. Most of all, repaying debt will relieve the psychological weight you've been carrying for so long. Don't underestimate the feeling of freedom that comes from no longer having creditors.
- Fix the things that are broken. After you've eliminated any existing debt, use your windfall to repair whatever is broken in your life. Start with your own health. If you've been putting off a trip to the dentist or a medical procedure, take care of it. Do the same for your family. Next, fix your car or the roof or the sidewalk. Use this opportunity to patch up the things you've been putting off.
- Deposit the rest of the money in a safe account. It can be tempting to spend the rest of your windfall on a new motorcycle or new furniture or new house. Don't do it. Take some time to breathe. After attending to your immediate needs, deposit the remaining money in a new savings account separate from the rest of your bank accounts. Be sure that the account is as difficult to access as possible — no ATM card, no easy transfer to your other accounts, no nothing. (An online savings account is good for this. So is an account at a small, local bank in the next town over.)
- Make a wish list. Allow your initial emotion to pass, getting over the urge to spend the money now. Live as you were before. Meanwhile, spend some time learning how far your windfall could go. Most people have unrealistic expectations about how much $10,000 or $100,000 can buy. Resist the temptation to spend the money now, but do run the numbers to see what you could buy.
In the end, it's often best to take the remainder of a large windfall and invest it for growth.
You've already repaid your debt and fixed the things that are broken, both of which are methods to spend on your past. You've also used 5 percent to treat yourself and your family, which is money spent on your present. The smartest move with the rest of the money is to spend on your future by funneling the funds into an investment account. (If you don't know how to do this, consult an investment professional.)
When I sold Get Rich Slowly in 2009, I received a large windfall. The old J.D. would have gone crazy with the money. The new, improved model of me was prepared, however, and made measured moves designed to favor long-term happiness over short-term happiness. Yes, I spent some money on new furniture and a trip to Europe. But I also set aside money to pay my taxes (fortunately, I was debt-free by that point) and to fix the problems in my life. (I was 50 pounds overweight in 2009, so I allocated $200 per month to becoming fit.)
Today, the bulk of my windfall still sits in the same place it's been for the past five years: an investment account. When first I put the money there, I thought I might use it for something in the not-so-distant future. That didn't happen, and now I've had time to get used to the idea that I have a large chunk of money that can act as a sort of “personal insurance.” That cash eases my mind. It helps me sleep easy at night. And that's more rewarding than spending it on new toys could ever be.
Author: J.D. Roth
In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.