NEW YORK (MainStreet) — Whether it's a structured settlement, an inheritance or even lottery winnings, cash windfalls happen. But if you're lucky enough to get a cash windfall, the last thing you should do is squander it. Before you start spending that big chunk of change that landed in your lap, get some solid advice on how to spend it the right way.
Wait Before You Do Anything
Chris Hogan, a personal finance expert and Ramsey speaker, says he constantly has people coming to him and asking what to do with cash windfalls. People's clueless approach can be dangerous. "I've seen people blow through $200,000 inheritances simply because they didn't have a plan for it," he says. So his advice is now always to put the money in a money market account until they know what they're going to do with it. "Park the money, get a game plan, then move forward," he says. You might not have to park the money for long, but taking a deep breath before you spend anything is a prudent move.
Realize You Can Have Your Cake and Eat It Too
"There's nothing wrong with enjoying some of it," says Hogan. "Not all of it has to be used for financial responsibility." Just how much should go to frivolous fun? "When I talk people through it, I don't have a percentage breakdown, but I do tell them to use common sense" he says. "If you get $20,000, don't spend $15,000 on a vacation. But maybe take $3,00 and take a trip and have some fun." Hogan says that it's important to think in terms of dollar amounts rather than charts and percentages. "People spend dollars," he says. "Percentages are this thing that people who are good at math can do. But most people don't think that way." Hogan says he has literally taken over $20,000 in cash and laid it on the table to show how much the person is going to spend on fun and how much they're going to spend responsibly. Visualization is a powerful tool for conceptualizing money.
Prioritize Your Spending
Ellie Kay, a family finance expert, is likewise often being asked what people can do with their financial windfall. "My first question is always 'how much consumer debt do you have?'" she says. Oftentimes, they have a lot. So Kay says that you should begin by paying down as much of that as you possibly can. From there, you want to try and get your rainy day fun of between three and six months of expenses in order. After that, it's time to start paying off depreciating assets like cars, boats and motorcycles. "The way I look at the windfall is, the average American is going to spend $146,000 in interest throughout their lifetime," she says. "That's just the average. People with bad credit are paying $246,000. But if you get a windfall, why not pay yourself?"
Once you've gone through all of those steps, Kay says you need to make sure you're fully funding your 401(k) to whatever the limits are. That includes both an account for you and for your spouse. "If you have anything left after that, don't fancy yourself some kind of day trader or big-time investor," she says. "If you want to day trade you might as well go to Vegas." Instead, throw the money into a safer investment like an exchange-traded fund or another index fund. Kay also recommends a fixed index annuity so the money is tied up. When you get a cash windfall, it's not uncommon for people to have friends and relatives alike knocking on doors asking for help.
Another thing that Kay recommends for particularly big windfalls is to look into real estate investing. "You can get a modest property at a low cost," she says. "If you can handle the payments and the upkeep, this might be the perfect opportunity to start investing in an additional stream of income." You want to make sure that you're in a renter's market, and you need to research how to manage investment properties effectively. But once you've done your homework, your cash windfall can keep you in the money for years to come.
"What most people do is turn upside down what I just said," Kay says. "They spend 90% instead on splurging instead of 10%." The exact percentage isn't the important part. But what is important is that you use the money wisely. You're not likely to get another windfall soon.