What would you do if you received a windfall today? While the classic story of a long-lost relative leaving you millions is often seen as a fairytale, it's not as rare as you think. Every single day, people come into large sums of money, whether it's a thousand dollars or a million, and without proper planning, funds quickly disappear. Just look at the horrible stories you often hear of lottery winners, and you'll have enough evidence that everyone needs a little preparation, even if you don't expect to get a windfall.
Let's say you come into an inheritance or sell your business or win the lottery: What should you do next?
Don't Change Anything for One Year. What's the first thing lottery winners do after they get their lump sum? They buy shiny new expensive toys—sports cars, mansions, yachts. Then it's motorcycles, jet skis, and anything else they can think of that goes fast, goes high, or does both. If you come into some funds, the first thing you should do is throw it into a savings account and wait rather than inflate your lifestyle.
If you might owe taxes on the windfall, make sure to talk to an accountant and set those funds aside. Lottery winners are lucky in this regard as well, since the lottery commission will usually withhold that portion of the proceeds.
Pay Off Debt. Do you have any outstanding high-interest debt? If the interest rate is higher than a mortgage, currently in the mid-single digits, then you'll want to pay it off as soon as you can. If you have any credit-card debt, now is a fantastic time to get out from under its burdensome shadow. Paying off your debt will not only free up your future cash flow, it will also improve your credit score. Improving your score will make a lot of other things easier.
Seek Financial Advice. Speak with a fee-only financial adviser or planner with good credentials and great references. If it's a small sum of a few thousand dollars, you can skip this step. If the sum is much bigger, consider paying an adviser $150 to $200 an hour for expert advice on what you should do. The adviser should be certified as a certified financial planner and should charge by the hour. Skip planners who are commission-based because they may recommend investments or insurance that benefits them more than you.
When you meet with a financial adviser, you'll want to go through your entire financial plan, including your goals and wishes for the next five or ten years, if not beyond. They should be able to help you craft a plan that will take you well into your own retirement. You want to make sure the windfall achieves your goals, and an adviser can help you do that.
Enjoy It. Once you've done the responsible things, like paying off debt and talking to an adviser, start to have some fun. Take a little bit of the windfall and treat you and your family to something nice, be it a trip, a new car, or something else that's been on your wishlist. Don't go crazy, but recognize that it's OK to reward yourself, especially if you're doing everything else right.
If you came into a large sum of money, what would you do with it?
Jim Wang writes about personal finance at Bargaineering and is also a regular contributor at Plan for the Sale. If you are having trouble spending your windfall, feel free to email him, because he's always looking for windfalls.