Saturday, October 27, 2012

What to Do with a Windfall, Part I

Windfalls do happen. A relative dies and you inherit some cash. You get an insurance payout. You sell something for big money. You get a large cash bonus from your employer. You win a lawsuit. You get a lump sum distribution on an investment. You win the lottery.
What do you do with this money? You never planned for it. It's not in any budget. Sometimes it's an enormous sum, which is even more terrifying. It's more money than you ever saw in one place in your entire life. What do you do with the money?

First, take a deep breath. Put the money in a federally insured bank account that pays interest. If it is over the amount insurable by one bank, create several bank accounts at different banks so the money is fully insured. Then take another deep breath. Your money is safe. It might not be earning you much of anything at today's interest rates, but it's still completely safe. If you do absolutely nothing, your money will still be there. If your windfall occurred because of some tragic event, take your time deciding what to do next. Allow yourself to heal a bit before you tackle what to do with the money. It’ll be there when you are ready.

Next, make a list of all your assets and all your debts. Everything. The car loan, the mortgage, the 401k, the college tuition fund, the college loan, credit card balances, what you owe your brother, everything. In other words, determine your current net worth. If your net worth is negative, it’s pretty obvious that you’ll need to use some of your windfall to pay down debt. Do it wisely. First pay the credit cards and the student loans, both of which have the potential to increase their interest rates and haunt you for decades. Car loans should go next since vehicles are a depreciating asset. After those immediate needs are taken care of (and you’ve paid back any relatives or friends to whom you owe money), you need to think.

Take your time again. Even a million dollar windfall starts to look like peanuts when you divide it by the number of years you can expect to live. If you have another 60 years to go, that cool million is only $16,667 per year, not including any earnings it generates. Not a fortune unless you can turn it into a lifelong moneymaker. What you want to do with the windfall is determine how it can change your life for the better.

Depending on how public your windfall is, you will likely be inundated with pleas from family and friends for loans or outright gifts, plus from total strangers who want you to pay for their medical bills. Do not yield to guilt-inducing pressure. Few of these importuning individuals will have your back if you run out of cash. Their pleas are a distraction when you ought to be educating yourself about the best way to manage your windfall.

Here is where advice diverges radically. Some people will tell you to buy an annuity that will pay you an income for life. Others will suggest a deferred annuity that kicks in only when you are in your final years. Others will of course recommend the stock market, the bond market, or various other investments that are meant to increase capital but hopefully will also preserve it. Some people want you to buy life insurance. Others, most of them outright crooks, want you to invest in various get-rich-quick schemes or buy overpriced precious metals. That’s the problem with receiving a windfall. Everybody has a great idea about how you can spend it. Meanwhile, you're trying to cope with the shock of having all that money.

Next Post: What to Do with a Windfall, Part II