How to manage a windfall successfully

This entry is part of JLP's October project — a month-long, cross-blog review of the book The Bogleheads' Guide to Investing. Some of what follows is taken directly from the book.

You have won $50,000! So, what do you do now?

Every day I give advice on following the slow, sure path to wealth. But what happens if you do manage to get rich quickly? What happens if you win the lottery, or hit the jackpot in Vegas, or inherit a million bucks from your Great Aunt Tilley?

The Bogleheads' Guide to Investing notes that many people receive windfalls at some point in their lives. Most windfalls aren't of the million-dollar variety — most are on the order of tens of thousands of dollars. It's possible to receive large lump sum payments from:

  • Inheritance
  • Divorce settlement
  • Insurance settlement
  • Lawsuit settlement
  • Real-estate sale
  • An income bonus
  • The sale of a business
  • Retirement
  • Etc.

What if you inherit $25,000? First, it's important to understand that windfalls involve more than money. Sudden wealth involves strong emotion, values, and personal psychology. How you cope with fortune depends on who you are. It's not uncommon for a person who strikes it rich to feel guilt or fear. And, more often than not, the wealth is squandered quickly. According to The Bogleheads' Guide to Investing:

Most financial practitioners agree that well over 50 percent [of windfalls] are lost in a relatively short period of time. NBC News reported that more than 70 percent of lottery winners exhaust their fortunes within three years.

What should you do if you suddenly find yourself with a lot of money? Surprisingly, few personal finance books tackle the subject. Only one other book in my library addresses the issue. The Only Investment Guide You'll Ever Need includes a chapter entitled “What To Do If You Inherit a Million Dollars; What To Do Otherwise”. If you strike it rich, the book advises:

  1. Go out for a very nice dinner.
  2. Put about one year of living expenses into a savings account.
  3. Put the rest in diversified investments.
  4. Be sure your will is in order.

Andrew Tobias is a witty writer, and The Only Investment Guide You'll Ever Need is filled with great advice, but I think his recommendation for coping with windfalls is too “mechanical”. It fails to consider human nature. It assumes that everyone has the patience and wisdom to make the right choice. The advice in The Bogleheads' Guide to Investing is more practical. Because of the emotional and psychological issues involved, the authors recommend caution and the following course of action:

  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 has 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.

The Bogleheads' advice is sound. If you follow these steps, you'll enjoy prolonged benefit from your windfall. Like the other reviewers before me, I think that The Bogleheads' Guide to Investing is filled with excellent, down-to-earth investment advice. It's not a comprehensive personal finance book, but its advice on investing is spot-on. It's certainly worth borrowing from your public library, and perhaps even worth purchasing.

(While researching this entry, I found this Liz Pulliam Weston article, which contains similar advice.)

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rich
rich
13 years ago

The best instructions I’ve ever read on what to do if you win big (bigger than $50,000, for that matter) in a lottery are in the Rotten Library:

http://www.rotten.com/library/culture/lottery-winners/

Please note that much of the excellent Rotten Library is not safe for work, and pretty much all of the *rest* of Rotten.com is not excellent and *very, very, very* not safe for work. But that one page about lotteries is safe for work.

prlinkbiz
prlinkbiz
13 years ago

It’s not that much money ya’ll- but if it is immediately put back into income producing investments, you’ll be set up for life. Savings and slow moving investment vehicles will lose you money over time. Learn self control and learn to grow and keep the money you make today so if you ever have a windfall you will already be trained.

Cat
Cat
13 years ago

This seems like a very instructive book, from the reviews I’ve read on different blogs. I look forward to reading it. My husband and I have also been reading “The Warren Buffet Way,” and it also has great investing advice. Anyone who has read “The Millionaire Next Door” should be truly motivated to follow the Bogleheads’ advice. Saving money takes a lot of self restraint, but it will pay off in the long run.

prlinkbiz
prlinkbiz
13 years ago

Saving money will pay off in the long run? Only if you put it back into income producing assets.

Hal
Hal
13 years ago

Put 12 months salary in savings??? What ever happened to 3-6 months?!?

All that cash seems like a wasted opportunity to buy mutual funds.

FIREFinance
FIREFinance
13 years ago

Great Review. Thanks a lot for your hard work.
Cheers,
FIRE Finance

Brendan
Brendan
13 years ago

Great review. I reviewed this chapter too.

It has to be almost impossible not to go out and spend the money immediatly. I’ve never received a windfall at all, but friends have and they immediately try to boost their social standing by displaying their new found wealth.

Successful Personal Finance.com

Adventures In Money Making
Adventures In Money Making
13 years ago

well i’ve never inherited or won anything, but i’ve come into considerable lumps of change.
the first time was about 2.5 times my annual salary, the second was about 1.1 times annual salary and just recently about 80% of my annual salary.

they all came from sale of appreciated property. 10% goes towards splurging and the rest gets reinvested.

deRuiter
deRuiter
12 years ago

Well this isn’t so hard! Take a deep breath! Mourn dear Auntie Maude or whomever kicked the bucket and left this largesse. 1. Pay taxes due if any. 2. Pay off your debts and cut up credit cards. 3. Splurge with 5% of whatever you got, if you’re into splurging. 4. Pay off your mortgage or pay down a big chunk of the mortgage, SO YOU WILL HAVE SOMETHING IF YOU SCREW UP WITH THE REST OF THE SWAG. Invest the balance in index funds and a bit in Coca Cola or Walmart stock. Relax and enjoy life. By paying… Read more »

Bruce
Bruce
11 years ago

After being in a fatal car accident when I was 16, I was awarded an insurance settlement which would be payed out over 4 equal checks, 1 every year, starting on my 18th birthday. The 3rd check is due to be here any week now and let me just say from experience…DO NOT SPLURGE WITHOUT AN INVESTMENT PLAN. From here on out, I plan to pay off debt I’ve accumulated, secure $ in a savings account to pay for the rest of my college tuition, set up a Roth IRA and stick the remainder in a relatively volatile mutual fund…I’m… Read more »

davr
davr
10 years ago

If you have blown a windfall in the past that is what you will do in the future.

If you are a prudent person with money you will be prudent with a windfall.

My wife and I would spend a small amount on some things we have been wanting for a long time. The rest would go into a diversified investment portfolio.

The first thing I would do is talk to a good tax consultant and a lawyer whose clients have money.

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