When a financial windfall happens – from the sale of a business, the sale of a house or farm, an inheritance, or even lottery winnings – you would think you’d be on easy streets.
But, sudden wealth can play havoc with your emotions, your relationships, and your life, and even leave you worse off financially than you were before. A famous study* found that lottery winners in Florida were twice as likely to file for bankruptcy than regular citizens. That’s because people who acquire large sums of money all at once, rather than building it up gradually over time, often lack the skills to manage it wisely.
Here are some steps you can take to turn “sudden wealth” into “lasting wealth.”
Put together a team
The more money you have, the more complicated your financial situation becomes, and the more there is at stake. So it’s essential to assemble a team of experts who will guide and support you. You will need accounting and tax advice, investment management, estate and trust strategies, as well as insurance. A financial advisor can act as the quarterback for all of these relationships, ensuring an integrated strategy and timely execution of your plan.
Know your tax liability
How much you get and how much you get to keep is not the same unless it’s the sale of your principal residence, life insurance proceeds, or lottery winnings. The sale of a cottage attracts capital gains tax on the appreciation of the property going back to your original purchase price. Inheritance will trigger estate taxes and fees, and a severance package or a performance bonus will be taxed at your highest income tax rate. It is important to understand how much money you are going to end up having after tax. Seek counsel on how you can legally reduce or defer the taxes payable on your windfall.
Devise a solid financial plan
To succeed in achieving your most important goals, you need a solid financial plan. First, consider your needs and desires carefully. Reflect on what and who are most important to you.
Together with your financial advisor, look at your options and make decisions. Will you retire or buy a vacation home? Will you give money to charity and set up trust funds for your children? How much income do you need and how much do you want?
Through financial planning tools and assumptions of interest rates and rates of return, your advisor can project what strategies you will need to follow to successfully meet your goals, even those that are 10 or 20 years down the road.
Invest Responsibly
The bulk of your money should be invested in a variety of investment vehicles that are professionally managed. Your financial advisor will help you choose from the different investment solutions to find the one that is suitable for you. It could be wrap programs that provide a combination of pooled investments in one easy package tailored to your needs, or a unified managed account (UMA) that holds a variety of investment vehicles, from individual securities, mutual funds, stocks, and bonds to exchange-traded funds.
Diversification is perhaps the most important concept. If you invest in a wide variety of securities, countries, and sectors, the underperformance of a single investment will not hurt the value of your entire portfolio.
Recognize that you can’t have it all – there is always a trade-off between risk and return. The safer the investment, the less return it generates. The riskier the investment, the higher its return potential. Your ideal portfolio will balance your tolerance for risk with your need for return to achieve your goals.
To provide safety, part of your portfolio should be invested in a conservative asset class such as bonds. To provide growth potential, a portion of it should be invested in a higher risk asset class such as stocks. To maintain your ideal weightings, regular asset class rebalancing is vital.
Planning is the key to controlling outcomes
Sudden wealth sometimes comes instantly, but it isn’t always unexpected. If you are retiring and planning to sell your business, or if you are planning to downsize from an expensive house, you can do some advance planning. An inheritance plan can be designed to reduce taxes, family conflict, and even litigation (no one wants to see their inheritance eaten up by legal fees). Consider strategies for disbursing assets most advantageously before selling your business or piece of real estate.
Sudden wealth looks easy, and it can be if approached in the right way. With a prudent approach to stewarding your new-found money and a solid financial plan that reflects your priorities and goals, you’ll be able to enjoy your wealth and build a lasting legacy for your loved ones.
As your Financial Advisor, I can help you take control of your finances and build a multi-goal plan for you and your family. Call my office to discuss your situation.
* https://www.mitpressjournals.org/doi/abs/10.1162/REST_a_00114