The psychology behind the “Sudden Wealth Syndrome”
And how to successfully managing a financial windfall
We’ve all heard the stories. If not first hand, at least in various news reports and anecdotes. Some “lucky” person picks the winning numbers, prances before the cameras in what can only be described as a media lovefest, and lives happily ever after, free of financial worries.
OK, the first two points are correct, but the happily ever after doesn’t always materialize. In fact, in most cases, sudden money leaves the winner worse off than prior to their windfall. According to the National Endowment for Financial Education, about 70% of the people who suddenly receive such windfalls will lose it within a few years. Furthermore, it’s not just lottery winners that are often troubled with windfalls. What about inherited money? Divorce settlements? Business sales? Cashed-out stock options or large professional signing bonuses such as those paid to professional football and baseball players or those paid to the next big vocal talent that is discovered?
By the time they have been retired for two years, 78% of former
NFL players have gone bankrupt or are under financial stress…
Within five years of retirement, an estimated 60% of former NBA players are broke.
-Sports Illustrated, March 23, 2009
Many times, those who aren’t used to managing a large sum of money, mismanage the funds and wreck their lives in the process. As it turns out, it’s a variation on the theme of the Prodigal Son. Only the names and the details change. Of course, odds of winning or signing a life-changing cash event like a lottery or a professional contract are incredibly low.
We are more likely to be the recipient of an inheritance or an insurance settlement. And it’s the unexpected pile of cash that may create an initial sense of euphoria and a false sense of security.
The vast majority of people blow through [a financial windfall or inheritance] quickly,” said Jay Zagorsky, an economist and research scientist at The Ohio State University and author of a study on receiving an inheritance. Whether large or small, it can seem like “play money.” And that is where the danger may lurk.
In my career, I have advised all sorts of sudden wealth scenarios: the retired professional athlete, the lottery winner, the inherited wealth, the self-made wealth, the wealth from insurance. While the manner in which the received windfalls vary, it is important that each recipient handles both the emotional AND financial aspect of what has occurred objectively. So why do some struggle more than others?
Often it is due to the “context” of one’s own personal experience with life and money. For example, if I am advising someone that had never had financial security before, say eking out from paycheck to paycheck, it can be a really confusing time. They may fall prey to a false context that just because they now have access to money, that they will never have problems again. The reality is that more $ = more issues. Now, contrast the example above with someone that has built wealth slowly over time. This type of person has likely learned the important lessons of life and money management along the way. What this person has realized is that making money is easy, keeping it is hard.
So, that brings us to the important question. What should you do if you happen to be the beneficiary of a financial windfall?
10 steps to creating a firewall around your newfound stash of cash
1. First, do nothing. That’s right, do nothing. The temptation may be to buy a new car, take a luxury cruise, or upgrade your living arrangements. That can begin an unwise cascade of purchases that will likely leave you feeling regret.
I suggest you wait at least six months before embarking on any life-changing decisions. The time spent waiting and planning allows the “shock” of your newfound wealth to wear off.
Besides, you need to take time to learn exactly what you’ve received. Is it all cash? Is it stocks and bonds? Have you just become the owner of a business or real estate?
2. Talk to a trusted advisor. Find someone who has your interests at heart, not his or hers.
If you are expecting to receive a windfall or have already received an unexpected inflow of assets, let’s talk and see how we can incorporate it into your overall financial plan.
If you just signed your professional sports or performance contract, remember who your #1 fan really is, the IRS! Paying as much as 45% or more in combined federal and state taxes will add up quicker than you expect.
The suggestions I’ll provide below are what I call the basics, the fundamentals. They may not apply directly to you, but they are common sense tools designed to help you make smart decisions and prevent an expected or unexpected windfall from being squandered.
3. For most, doing nothing also means not quitting your job. It may be tempting, but lost wages and the lack of social interaction from your work buddies may lead to remorse, even if you don’t especially enjoy your job. Besides, without work, you run the risk of blowing through your money much quicker than you had anticipated. However, it is also deeper than just the money. You need time to adjust socially with this new wealth.
4. Reduce debt. We’ve always provided a holistic approach to financial planning. Once things have settled down and you have a better understanding of your new wealth, it may be time to pay down or pay off high-interest debt. Once eliminated, you no longer have that onerous outflow of interest payments on your loans.
5. If you don’t have an emergency fund, now is the time. Set aside reserves of at least six to nine months, preferably the latter. The future can sometimes throw you an unexpected curve ball. Having reserves set aside will reduce your financial stress.
6. Additionally, you may decide to allocate additional funds towardsavings and retirement. Again, every one of our clients is unique, with various goals, personal circumstances, and financial resources. What our team recommends for one person may vary significantly from what's best for another.
7. Think about tax and estate planning. No one is sure what may or may not happen to the tax code this year or next. But it’s critical that we get a handle on the tax ramifications of your new wealth in order to maximize the financial benefit.
For example, did you know that you may be required to take distributions if you inherit an IRA? What if you are already taking required mandatory distributions? You see, things can get tricky rapidly, but sound advice can quickly ease any concerns.
Additionally, life changes are a great time to update your estate plan, especially if an inheritance increases the complexity of your financial situation.
8. Be cautious. Less-than-reputable salespeople and relatives may suddenly warm up to you, with the unspoken goal of separating you from your cash. That’s why a trusted advisor is critical. If you have a well-thought-out financial plan, it’s much easier to pass on potentially exploitative offers. It easier for you to say your financial adviser said “no” than for you to say “no” to these types of requests.
9. Consider charitable giving. Do you have a favorite charity? Would you like to help a niece or nephew finance their education? Now is the opportunity to explore the possibility of helping others.
10. Have some fun. There’s nothing wrong with treating yourself. As we provide counsel, we would like to leave some room for self-indulgence. A budget is something that works for everyone, regardless of their level of wealth. The most successful clients we advise all manage a basic budget.
Do you like to travel? Have you thought about an addition to you home, finishing your basement, remodeling your kitchen, or upgrading appliances? Maybe it’s those top-of-the-line golf clubs you’ve been eying, or a new car.
Or, maybe you’d like to spend money catching up on the everyday things of life you’ve been putting off. Everyone has a hot button. At Capital Resource Management, we call it “Let’s Answer Your Why”. It would give us an immense amount of pleasure helping you achieve your dreams.
With a financial plan in place that manages your windfall, either large or small, you’ll feel much more secure enjoying the benefits of your wealth without the nagging worries that you might run through your nest egg with not much to show for it.
If anything here resonates and you are interested in learning more about our comprehensive wealth management services, we are as close as the nearest telephone.
Phil E. Gose, Capital Resource Management