While most adults accumulate wealth by carefully investing and saving over time, a substantial number of adults receive a windfall from one-time circumstances like the sale of their company, an unexpected inheritance or family gift, a lottery win, funds from an insurance settlement, or a corporate bonus. Financial advisors call this influx of money sudden wealth and it’s surprisingly complex.
This new financial surplus brings with it a great opportunity to prepare for the future, accelerate existing plans (graduate school with no loans!) or take calculated risks, such as starting or investing in a business. However, there are also many who burn through this sudden wealth with mistakes in over-spending (too many pricey toys) or failing to understand the opportunity costs of their choices. When sudden wealth happens, it is important to sit down with a financial advisor who can help navigate taxes, debt, and investment or career choices in light of their new resources—because few people are blessed with sudden wealth more than once in a lifetime.
Additionally, it may be important to talk to a professional counselor, as well. Many people who come into unanticipated money or move up the economic ladder experience what psychologists call “Sudden Wealth Syndrome.” They experience a loss of identity, anxiety about managing and preserving their new funds, and confusion about whether they deserved the funds received. These feelings are often complicated by envy and biased or poor advice from well-meaning friends and loved ones.
Here are a few insights we’ve gathered from advisors who have shared their perspective on Sudden Wealth:
1. Pause and exhale
“If you’ve received a windfall, it’s important to pause first and assess the situation,” says Rita Cheng, CEO of Blue Ocean Global Wealth in Gaithersburg, Md.
“You need to give yourself time to occupy a decision-free zone,” Cheng says. “Don’t rush into decisions.”
Instead of jumping right into something because you’ve got the money, it’s important to take some time to think about your values and the lifestyle you want to live, and then talk to an advisor about how to create that scenario. It’s also wise to engage related advisors such as a CPA or an estate lawyer.
Before you spend or invest any of the funds, you’ll want to understand the estate and tax consequences linked to your windfall, as well as what percentage of the funds should be placed in short-term or accessible accounts versus long-term savings and investing vehicles. This is particularly important to understand in advance of taxes, so you don’t face penalties for withdrawing invested money to pay taxes you didn’t anticipate.
2. Understand your new investment opportunities
Many adults who come into sudden wealth become “accredited investors” which is generally defined as owning assets (excluding a primary home) worth in excess of $1 million. Because of this changed status, a bevy of new investment opportunities is now available to them simply due to their achieving a higher net worth. Being accredited simply means said net worth is now viewed to be capable of withstanding the different risks or illiquidity of certain investments which carry potentially high returns, but also plenty of risks.
“Investors who become ‘accredited’ need to understand that some of their new investment choices are illiquid and that fee structures for some of these investments are different than what they’ve known in the past,” Rita Cheng notes. “They also need to understand that some decisions they make with their money are irrevocable once chosen.”
Closed-end mutual funds, alternative investments, or hedge funds may readily take the investor’s money but in some cases, the investor can’t sell out of these investment types until another investor wants to buy in, she notes. Investors need to know the caveats. Separately, investors with a large pool of funds to draw from could use their wealth to pay off debt (pre-pay the mortgage) or pre-fund future expenses (a child’s tuition). But once that money is spent, it’s no longer available for other opportunities or emergencies.
Let GuideVine.com help Find the Right Advisor for you!
3. Consider whether you’ll live on the money, leave it to heirs—or both
“People who receive a windfall and don’t already have a financial plan may be at the most risk of making mistakes with their new money,” notes John Flavin, a CFP with Synergy Financial Management in Seattle. “I know of an investor who received $1 million unexpectedly and blew it all within three years,” he says. “I’ve seen other such clients charter jets to fly their families around when if they wanted a splurge it might’ve made sense to just fly first class once or twice,” Flavin says he looks at investments for his clients in two ways:
- Capital Consumption – for those concerned about not outliving their funds, how long will the money last at a given rate or return?
- Capital Preservation – for those wanting to leave a legacy, how should the money be invested and at what rate so the maximum is available at the time of death?
Depending on a client’s goals and needed rate of return to achieve those goals, many scenarios will be possible.
Some investors may have a “base plan” for the majority of their money (75% to 80%) and use the remainder (20% to 25%) for more experimental investing and spending (hedge funds, launching a business, etc.) A sound financial plan can protect the investor and place him or her into appropriately risky investments while also allowing them to experiment with the risks and rewards available in the market.
Take an investor with $2 million. Their base plan might call for $1.5 million invested at a target 5% rate of return but also include some discretionary spending for an annual $10,000 trip. The rest of their portfolio, say $500,000, might be allocated to investments for accredited investors or to fund the costs of investing in or launching a business.
4. The money won’t last forever
“No matter how much money you have, people have to understand that eventually, if you’re spending it, it will go away,” John Flavin notes. “Some people who come into sudden wealth seem to forget about that.”
That’s why to him, the best financial plans incorporate conventional investments designed to make the money last while allowing the client some room to explore untapped opportunities and new types of experiences that the money allows them to pursue.
“A million dollars seems like a huge amount of money to someone who hasn’t seen that many zeros on their balance sheet before,” he says. “But when you’re retired and withdrawing $50,000 a year, that lasts about two decades–excluding interest earned.”
What an investor chooses to do with their sudden wealth can write a variety of scripts for how their and their families’ lives unfurl. So it’s more important than ever to use planning to protect and grow the funds, while also allowing for experimentation, philanthropy, or another expression of the investor’s values.
Book a Free Appointment with a GuideVine concierge today!