What should I do with a windfall, such as a $500K inheritance from a long lost Uncle or a larger sign-on bonus than expected?
A.
Two of my favorite investing/finance books, The Bogleheads Guide To Investing, and The Only Investment Guide You'll Ever Need, each have an entire chapter on this subject that are well worth reading. The Bogleheads Wiki also has a nice page on it. I prefer to divide windfalls into three categories:
Category 1: Spare Cash
This is money, perhaps $10-200K, that you weren't expecting. I would just fold this money into my existing financial plan. For example, I might be paying off student loans, paying down a mortgage, trying to max out retirement accounts, putting money toward the kid's college, and trying to save up for a new car. I'd just take this money and divide it among my goals in whatever manner I see fit, trying to minimize interest, decrease taxes, and maximize returns. Right out of residency, it might all go toward my student loans. If I were 50, it might go all toward the mortgage. But more likely, it would be split between the various options. If you're not maxing your current retirement accounts, perhaps live off the windfall for a few months to allow you to max them out, essentially converting a taxable account to a tax-protected account.
Category 2: Enough Money To Make You Financially Independent
Consider this an inheritance of $1-2 Million. This is enough money to really change your life in a significant way. The best thing to do upon getting this money is nothing, at least for a period of a few months or a year. Give it some time and really think about what you want to do with your life. Ready to retire? Do so. Want to get out of medicine and write books? Now's your chance. Still love what you're doing? Perhaps put a chunk toward retirement, give some away, and spend some.
Category 3: Ridiculous Money
This is when you get a windfall, such as lottery winnings, which if invested wisely, is more money than you would ever spend given your current lifestyle. While somewhat similar to category 2, it is different in some important ways. You now need to engage in some serious estate planning for instance. You also have the opportunity to make real change in your community and the world, a responsibility not to be taken lightly. You'll also have to fend off the hordes who want you to share the money with them!
I really like Andrew Tobias's recommendations for what to do if you win a million dollars. Here's what he says:
1) Go out for a very nice dinner.
2) Put about one year of normal living expenses someplace liquid, like a bank or money market fund.
3) Put roughly equal sums into US Treasury securities maturing in one, two, three, and four years.
4) Put the bulk of the remaining money into stock-index funds, split between domestic and foreign investments.
5) Buy a country place or a bigger house, if you want one–but not so big that the cost of carrying it will in any way strain you. 5A- If you have the inclination and can find a good value, buy a small rental property too. It will provide an inflation hedge and a little tax shelter. 5B- Do not buy a boat.
6) Be sure your will is in order.
7) Now, relax and forget the whole thing. Review it once a year, mainly to roll over your treasury securities as they come due. Don't spend any of the investment principal, but enjoy the extra income it throws off.
I find it interesting that these recommendations aren't really very different from what he recommends you do if you DON'T win a million dollars. Now, here's what I recommend you do with any significantly sized windfall.
Ten Rules For Managing A Large Windfall
1) Don't do anything quickly. There is no rush. Especially if the windfall is life insurance proceeds from the death of a loved one.
2) If we're talking about ridiculous money such as lottery winnings, try to keep anyone you know from finding out you have this money or how much it is. It is far more likely to ruin your life than to help it.
3) Consider annuitizing the money. Most lottery winners are broke within just a few years. If you annuitize it, at least over 20 years or more, you've got to screw up 20 separate times to go broke. That's a lot harder than screwing up once.
4) Seek out some solid, unbiased advice. Talk to a CPA for some tax advice and an attorney for some estate planning and asset protection advice. Pay them a fair, hourly rate. You may need to update insurance, especially liability insurance. Investing advice is far less important early on.
5) Pay off your debts. Don't take on any more. Life is no longer about increasing returns, but about minimizing risks. Having debt generally increases your risks.
6) Put a big chunk of the money into very safe investments-CDs, treasuries, bank accounts, money market funds etc. You now have a much lower need to take investment risk than you had prior to this windfall. Take advantage of that by taking less risk.
7) Spend some money. But don't spend it on something that requires significant ongoing expenses. Take a luxurious trip around the world or buy a new truck or something. Don't buy a 10,000 square foot house or a $2 Million yacht.
8) Give some money away….to some real charities, not your brother-in-law and Ray across the street.
9) Write down a plan for how you're going to deal financially with family and friends. Tell them what it is, and stick to it.
10) Remember that one of the benefits of having enough money is that you don't have to maximize it. You only need a plan that is good enough. You don't need to get every last dollar out of your inheritance. As Tobias says, not having to try [to maximize the money] is one of the luxuries that being a millionaire should bring.
What do you think? Have you had a windfall? What did you do with it? What advice do you have to someone who comes into $50K, $2 Million, or $100 Million? Comment below!
Image Credit: Sergio Pitrau, via wikimedia, CC-BY-SA
Ah…if only…
I don’t see one coming my way but this article did bring up a question I have had for the WCI:
What are your thoughts on CD Ladders and/or Treasury Ladders. Back in my Army days I was considering doing a CD Ladder but with the rates as low as they are I haven’t bothered. Thoughts?
I prefer the simplicity of a bank account or a mutual fund, but there’s nothing wrong with laddering CDs or treasuries. It’s actually cheaper to ladder TIPS than to buy a TIPS fund, but there is a significant hassle factor there. Check out this recent Bogleheads thread:
http://www.bogleheads.org/forum/viewtopic.php?f=1&t=107175
Well I wanted to retire and had as a principal that I should be able to live off the income. This meant a portion invested in dividend stocks, reits, and then some opportunities to purchase individual stocks at attractive prices. My situation was such that I had to pay income taxes as well.
For very large amounts I agree that keeping the “folks” out of your business is good, but almost impossible. I hate the return on CD’s, treasuries etc., but if you have enough money putting some into these is a good idea.
I recommend reading two books:
1) Family Wealth: Keeping it in the Family. How Family Members and Their Advisers Preserve Human, Intellectual, and Financial Assets for Generations.
2) Preparing Heirs. Five Steps to a Successful Transition of Family Wealth and Values.
These books address the issues that come up after the accumulation phase of building wealth.
This is what I have planned so far…
I live in a small but beautiful town house with a huge lake and bicycle path as my backyard, so I want to stay here for the immediate future.
Me…renovate, furnish my town home. Get some medical things taken care of, etc.
Husband… A generous trust and a separate town house for my husband (who I will divorce), renovated, furnished, and a monthly payment to live off. monthly bills will be paid by the trust. I want him to be taken care of as he doesn’t seem to be able to do this for himself.
Disabled child… A generous trust and separate town house for my adult disabled child. again renovated, decorated, furnished, monthly payment to live off, bills paid, driver, car, all his future needs met etc.
Able child… I’d pay off her home loan, with an extra 100k for renovations etc., and send 2 new cars anonymously. Of course I’d set up trusts for the grandkids – without them knowing..
And I want to use donations to a local wildlife shelter as some tax benefits..
No idea what I should do with the main money yet. Or anything else I have missed. Any suggestions?
Sue,
In your situation you REALLY should read the two book I listed above your post.
I’m not a white-coat investor. You folks would call my coat grey. I have a Ph.D., and I teach. My parents were also teachers and incredible savers. A few years ago, I inherited almost a million dollars. I’m in my 40s. I paid taxes, took about 8 percent and bought myself a year of work-free writing time, and invested the rest. With the market recovery, I’ve already made back and then some the small chunk I spent.
One thing I noted was that the investment people I talked to wanted me to do really stupid things like buy lots of whole life and lots of annuities. I had to dump two advisers who were almost attacking me to get hundreds of thousands into whole life. It was pretty awful. One of them said, “Don’t you trust me?” Honestly, no. What I’ve done with the money is spread it out as best I can among asset classes: including stock funds, a fairly high interest CD (I was able to get almost 3 percent; low, I know, but high compared to most CDs these days, and it provides me both safety and some income) and commercial real estate. The REIT has brought in 32% in the last 18 months and has fairly high dividend yields. My long-term plans are to income invest as best I can and set myself up for about 100k a year in dividend income in my late 60s and leave an estate of about 5 million.
hello. how to get Inheritance Funds? because my family has a debt please help me. thank you
How to get an inheritance? Talk someone into leaving you one I guess. But if the person leaving you money has debt, that gets paid by the estate before the heirs get any inheritance.
You get lucky in the lottery of life, be born to compulsive savers, and preserve and grow it by being one yourself. Most of all, be the kind of person who is incredibly grateful, willing to learn about investing, and willing to fend off all predators, including whole-life insurance salesman. It’s not the getting it, it’s the using it with dignity and grace that is the rub. Most inheritances get destroyed by the beneficiary within 18 months. Be one of the five percent who doesn’t.
I came back to read this article in hopes of a little direction should my anesthesia group get bought out this year. The group we are looking into joining doesn’t buy us out for a huge sum and instead buys us out for a modest sum and then takes 20% of our profits in perpetuity. So the buyout won’t be in the 7 figures but more like $500k-$1M. Which type of windfall should we treat this as? Spare cash if it’s on the lower end? And “enough money to retire” if it’s on the higher end? What about somewhere in the middle?
If it, combined with your current portfolio, makes you FI, then treat it as “enough money to retire.” If it doesn’t get you to FI, then invest it according to your plan.