What to Do — and Not Do — With a Windfall

A sudden pile of cash sounds great, but beware these pitfalls.

— -- Most people wish for a financial windfall, but they should be careful what they wish for. For many, receiving a large sum unexpectedly — or just suddenly — fails to solve the problems recipients thought it would, at least for the long term. And in some cases, a windfall brings less happiness rather than more.

Though many people know they’ll eventually receive an inheritance, many are nevertheless unprepared to handle it. With true windfalls — lawsuit settlements, corporate buyouts, lottery winnings and other large tranches of cash that aren’t long expected — preparation by recipients tends to be even more lacking.

This can lead to disappointment. Some recipients think they’ll never have to worry about money again, but because of the way they handle their windfalls, they end up being wrong about this. Yet, if those fortunate enough to get a windfall quickly develop a new level of discipline to match their new wealth, they can ensure that their good fortune remains good — that it changes their lives in a positive way.

Making up your mind to do this can help you avoid the following negative consequences of sudden fortune, including: New-money-itis. This is my term for the tendency to start spending on yourself and those around you as though the money will never run out. But it always does. No matter how much money comes your way, you can always spend it all — or so much of it that you’ll have thrown away your future. New-money-itis can play tricks on your mind, which blocks out the logical, inevitable result of unbridled spending: being broke again.

Damage to your mental and physical health. Years ago, I had a client who received a substantial corporate buyout to take early retirement at 53. I advised him to invest all of this money to recreate his former work paycheck, but he insisted on putting a big chunk of it in his checking account — the launching pad for spending. Before he got the buyout, he was calm and relatively care free, as his daily routine had been the same for 20 years. But afterward, his routine changed dramatically, as he had nowhere to be every day and no one telling him what to do. Before the buyout, he enjoyed going home to rest after work and rarely found time to spend money. Now he had all day to spend, and spending became an emotional replacement for work. He became nervous, agitated and prone to hyperventilating because he had developed an unhealthy obsession with spending, an unfulfilling endeavor in itself.

Risk to your financial health. You would think that the financial future of windfall recipients is assured. Yet often, windfalls result in a few years of ridiculous spending, amounting to a missed opportunity. This is perhaps true most often of recipients of the greatest windfalls: big lottery winners. Some studies show that about 70 percent of these winners end up broke. Between their heady days of winning and once again living paycheck to paycheck, there’s a period of foolish indulgence and giving in to a parade of sycophants seeking to exploit their friend’s or relative’s newfound wealth. Lottery winners say yes to everyone, leading to their ruin. While precious few people are lottery winners, taking note of this syndrome can be instructive, for it can take hold of recipients of other types of windfalls to a lesser extent.

Wasted life opportunity. A chance at financial independence or early retirement is a chance to do something meaningful with your spare time now that you don’t have to worry about income. If you apply your windfall wisely, this chance is increased. If you blow it, you lose this chance forever. Many retirees find that there’s more to life after work than just playing golf or whatever they did on weekends when they were working. Seeking a sense of purpose, they craft a retirement lifestyle that’s different from the traditional indolence-and-travel pattern. Doing something meaningful with their spare time becomes more important to more people as life expectancies increase. Will the 20-bedroom house you buy with your huge windfall really make you happy? Is that how you want to be remembered? Or do you have more substantial life goals whose pursuit and accomplishment you’ll find more satisfying?

To make the most of your windfall, settlement or buyout and make a positive difference in your life and that of those close to you, you may have to start thinking about money in a completely new way. Here are some points to keep in mind in achieving this mental evolution:

* There’s a big difference between money saved and earned gradually and money received suddenly. When people accumulate money gradually, there’s usually a good deal of incremental planning. When people get it suddenly, it can be overwhelming. Sudden wealth may come in the form of a contract for a young professional athlete or a big movie deal for a young actor — both in professions where financial management isn’t necessarily involved. Like many sudden wealth scenarios, these situations call for sound guidance. This guidance may be in the form of a qualified financial advisor. It’s important to remember that a good advisor isn’t one who agrees with everything you say. All too often, advisors like friends and acquaintances can steer you wrong by saying yes to be in your good graces and benefit from your good fortune. You want solid advice, not rubber-stamping.

* Make sure you have a plan. This advice or research should help you develop a solid financial plan — essential for preserving and protecting your wealth. Normally, you’d have to work long and hard to put aside money to build a large nest egg. The whole point of disciplined saving over a long period is to build a nest egg large enough to generate significant returns that can be reinvested, taking advantage of compounding.

* Avoid the trap of viewing your windfall as the only way to pay off debt. Some windfall recipients are eager to use a substantial amount of their good fortune to pay off substantial debt. Using some of a windfall for this purpose to eradicate high-interest debt might be a good idea, depending on the amounts and interest rates involved. But using a lot of it for this purpose has two distinct disadvantages: 1) It cuts into or eradicates your big pile of return-generating money, the returns from which might be greater than the interest rates on the debt, and which is extremely difficult to accumulate over time, and 2) it is an all-too-easy fix for debt. By paying off debt through gradually setting money aside for it, you make a sacrifice that you’re constantly reminded of, thus keeping you from going into debt again. It’s like losing weight by having a gastric bypass instead of doing the hard work of dieting. By developing dietary or financial discipline, you’re less likely to gain the weight back or slip back into debt.

The key to avoiding the mishandling of your windfall is to go slowly — to take some time to think about what you’re going to do. Decisions made in haste are rarely as sound as those you give more thought to. So if you receive a windfall, sit back and think about making a plan. And whatever you do, don’t start spending willy-nilly.

This column is the opinion of the author and in no way reflects the opinion of ABC News.

Byron L. Studdard, a CERTIFIED FINANCIAL PLANNER™ practitioner, is founder and president of Studdard Financial, LLC, a fee-only financial advisory firm in Sarasota, Fla., dedicated to helping clients build wealth, protect it and pass it on to future generations. Studdard has been listed in the Guide to America's Best Financial Planners (published by the Consumers' Research Council of America, an independent research organization). He can be reached at Byron@studdardfinancial.com. If you have a question for him, send him an email and he will try to answer it in an upcoming column.

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