Retiring? Inheriting? Winning the Lottery? How to Manage a Windfall

As of this writing (August 23, 2017) the Powerball jackpot is at $700 million.  With the promotion of the lottery showing that even if a single winner were to  take the winnings in a lump sum rather than over 30 years, they would have receive $443.3 million – a gamble worth taking.

The news coverage brings to mind other situations in life where people come into a sizable amount of cash all at once: inheritance, a divorce settlement, life insurance proceeds or the sale of a business. Granted, those windfalls are significantly less than $443 million, but as the late Illinois Senator Dirksen said, “a million here, a million there….pretty soon you’re talking real money.”  With any windfall, there is an immediate inclination to decide how to spend some (often quite a lot) and how to invest some (too often, very little). While a million dollars sounds like a lot of money – and it is – it is also a sum that can be spent pretty quickly if not thoughtfully managed.

So how do you manage receipt of a large lump sum to ensure it will best serve you?

1. Don’t do anything for at least a few weeks.

Often, a windfall of any kind brings with it an emotional high of sorts, and the urge to make quick use of the money can be strong.  However, there are significant financial consequences to many financial decisions, some of which may be intractable or very difficult to reverse. Let the knowledge sit for a while and allow things to settle down. Many lottery winners take weeks or much longer to claim their prize. In fact, it took several weeks for all three of the winners of a $1.5 billion lottery to come forward. But this doesn’t just apply to a massive lottery jackpot; it also applies to windfalls on a smaller scale. Hold off on buying that car you’ve always wanted. There will be time.

2. Seek professional guidance.  

There are tax implications and legal issues to receiving any payout. Usually, once you make a choice on how you will receive your money, you’re locked in. During your month of “letting it sink in,” find a wealth advisor, a CPA and a tax attorney you can trust. Some of the choices you may make in how you receive your funds and what you do with them can reduce their value.

This is also a good time to revisit your financial plan. If the new assets are a sizeable increase to your existing portfolio, it may afford you new choices: retire earlier, spend more or take less investment risk, for instance.

3. Stay focused on your career.

Coming into a million dollars would lead many people to conclude they’re all set. But invest that sum wisely and you can safely draw $30,000 to $50,000 per year for spending, less than what you would probably spend in a year if you weren’t working. One relevant note about work: it keeps us busy with activity that doesn’t cost us financially. Many of the things we enjoy doing outside of work are expensive.

In the case of a divorce settlement, get counsel to help understand what it takes to run your household before you make any decisions about how to spend it.

4. Retirement funds are another kind of lump sum with which you need to be particularly cautious.

When clients come in with a chunk of cash, they want to know, “How do we invest this? Put all in the market at once? Average in over time?”

Unfortunately, there is not an easy answer.

The best answer for each person depends on variables. For example, let’s say you have a 401(k), and it’s been invested half in stocks and half in bonds for the last 20 years. Now you’re retiring. Your first step may be to convert the fund into an IRA rollover. This would allow you to avoid the taxes you would pay drawing the funds out of the 401(k).

The next step may be to re-invest the funds allocated as they were originally: 50-50 between stocks and bonds. If you change your allocation all at once, you’re making a timing decision that locks you into a return that may not be optimum. If you want to reallocate away from the 50-50 distribution given your tolerance for risk, first reinvest at the same allocation and then seek counsel about the best way toward reallocation, depending on the time horizon for your investments.

In fact, time horizon is another important variable to consider. When will you need the cash? Historically, markets have gone up, but they can drop substantially in the short term. If you have at least a five or ten-year window, your odds of a good return are best if you’re invested in the stock market. In that case, history says today is the best day to invest. If you can leave the funds invested they’re likely going to be worth more over those years.

But what we don’t know is if in the next six months, the market will drop. It’s painful to watch your portfolio drop by a significant amount, even if you have faith that it will come back over time. Since investors feel more pain from the downside than pleasure from the upside, we often recommend the strategy of spreading investments over time to even out that risk. In other words, you could invest one-quarter of your cash now and another a few weeks after that and again a few weeks later, etc. This can be less stressful than investing it all at once.

And it’s also helpful to remember Warren Buffet’s advice: be fearful when others are greedy and be greedy when they’re fearful. If you had had cash in 2008, when we were in a recession and the stock market was down significantly, that was actually a very good time to invest. Take a look at what others are doing: if they’re all getting out, it could be an ideal time to buy and vice versa.

How Can Smith and Howard Wealth Management Help?

Smith and Howard Wealth Management is available to offer advice on how to protect the value of your investments and make sure your family’s financial future is secure.  One of the country’s top 100 fee-only wealth management firms, we serve as your family’s CFO.

If you’ve received a windfall or know someone who has, we’re happy to provide counsel. Please call me at 404-874-6244 or email me here.

Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.