5 Tips For Protecting Your Windfalls

In the fourth season of Arrested Development, the audience discovers the troubled Bluth family received a government stimulus bailout during the recession. Rather than using the “stimmy” to fix their troubling real estate family business operation, they used the money to buy 4,000 acres of worthless land in - well, I won't spoil it.

There's just something about money landing in one's lap that inspires cloudy thinking and poor decision-making. The cause-and-effect relationship between windfalls and mistakes with money exists beyond fictional television comedy, too.

People love reading and hearing stories about how the suddenly-wealthy often find themselves in financial trouble. If the story of a wealthy family that lost everything isn't appealing, there's always the story of poor families that are provided with an unusual opportunity who later squander their fortune. The most common is the prototypical lottery winner with no money-handling experience living on the street just a few years after taking winnings as a lump sum.

It would be easy to judge these poor folks. “If only they a better financial education or a more positive experience managing money in the first place,” one might say, “they'd be better prepared for dealing with a windfall.” It's a universal problem, too, affecting people who normally wouldn't be playing the lottery. Smart business leaders are just as likely to make mistakes. A recent story about the founder of a major technology business provides more anecdotal evidence for this type of occurrence.

CNET  featured a story about Harvey Minor, the founder of CNET and an investor in other tech-related companies. He sold CNET for a consideration of $1.8 billion. This is a guy who ran a major business; he should be fairly savvy about making financial decisions. Maybe it was his confidence that ruined him; several years later after the windfall, he's declaring bankruptcy.

Declaring bankruptcy isn't always such a bad thing from a business perspective. If the drawbacks like trashing your credit aren't important, it's an effective way to getting out of paying many of your debts. The stigma for bankruptcy is still well-deserved, and in this case, Harvey Minor even released a public statement when filing his bankruptcy, lamenting his mistakes.

He reaches inside himself to sum up his failures due investing beyond his areas of knowledge of expertise:

I have thought a lot about this and the reality is the seeds of my every failure can be found in my every success, and the seeds of my every success can be found in my every failure.

Some time during your life, there's a chance you might receive some kind of a windfall. It may not be Harvey Minor's $1.8 billion, but it may be enough to make some kind of difference in your life. Windfalls can be large and change your long-term goals, or they can be just enough to help propel you forward a short distance. There are a few things you should keep in mind to help you keep from ending in a worse position than where you were before the windfall, be it large or small.

The problem with tips like these is that they sound good from a planning perspective, but when you actually experience a windfall, they can be very difficult to follow. It's easy to get caught up in the emotions, pressure from peers can influence your decisions, and slippery slopes allow full failure to sneak up on you.

1. Take care of your obligations.

If you're in a good financial position, an unexpected windfall gives you the chance to have some fun and take part in experiences for which you might not have had the opportunity otherwise. The key is taking care of your obligations first. The first is going to be your taxes. The second is your debts.

Do you ever wonder why celebrities and other famous people seem to have problems with back taxes? Now, it might be simpler to assume that these people aren't very savvy about managing their finances. But in some cases, some seem to employ their tax troubles as a strategy: underpay taxes this year, using the extra money to invest, argue with the IRS when they audit, and pay later from profits of the investment, covering even interest and penalties.

There is no way I would ever recommend such a strategy; I just think that some of those often in the news for their tax problems are working with financial advisers who know how to work the IRS, savvier than the rest of the public.

Debt is the second part of the obligation. Use some of the windfall to pay off your debt so it's one less thing to worry about.

2. Stay out of the spotlight.

When you win the lottery, there may be a provision that you must speak with the media. Most windfalls don't come through lotteries, though. Keep a low profile. There's no need for people outside your closest social circle and your closest family members to know about your good fortune. When I began receiving what I would consider a windfall, although I was proud of the achievements that led up to that financial success, I rarely discussed the details, and only opened up to people who were close to me.

I had seen that when knowledge grows beyond a close set of individuals, or when people actively market their success, the unwanted attention could be damaging. Also, if you create a public image surrounding your financial success, you could be adding pressure on yourself to maintain that image, whether that means associating with different people or continuing to find similar success.

3. Stick with what you know.

Halsey Minor blames some of his financial failure on his desire to invest outside of his expertise. Generally, moving outside of a comfort zone is a good idea. It forces you to learn new skills, to be adaptive, and to work hard to succeed. A windfall can also create a cash cushion that allows you to take on new risks.

Overall, this is not a bad thing. The adaptation is the most important part. You have to be analytical, being very clear to yourself about what your limits are. If something is not working and you approach those limits, adjust and change direction. Despite all the proven dangers, one thing people immediately turn to when they receive a windfall is real estate investing. When people have money to spare, it just seems like a good idea. But if you don't know a lot about real estate - if you weren't a successful real estate investor before receiving the windfall - you're just asking for trouble.

There are thousands of “advisers” who would be willing to take your money and invest it for you. Brokers of all sorts are more than pleased when presented with a whale, fresh off the boat. (How's that for a mixed metaphor?)

4. Make a plan.

After taxes, put together a plan. Whether the windfall arrives in one shot or whether you're suddenly found yourself with an ongoing income stream, planning helps you take some emotion out of the situation. Life is emotion, psychology is  the only thing that goes into actual human behavior, so eliminating emotions is impossible. But you can learn to recognize the effect of your emotions on your decision-making and adjust. Planning is a big part of that.

If you want a rule of thumb, use this. After paying for your taxes and other immediate obligations like debt, use these proportions for your windfall. Half of your windfall should be directed towards the future, and half should be used in the present (or within the next few years). This will allow you to enjoy the fruits of your success while still planning for the future.

This is just a guideline. If, for example, you don't believe you have that much of a future and have no need for leaving a legacy, you can adjust the weighting in favor of short-term use. You might as well use what you can while you can.

So where does this leave investing? It's not much different - some investments are made for the long-term, some are made for the shorter term. If you have an opportunity to invest in something exciting and potentially profitable that will pay off in the next few years, use some of the short-term portion of your windfall. If you're investing to prepare for retirement more than a decade down the road, use your long-term portion.

5. Track your finances.

The same rule that people who are just beginning to organize their finances is the same rule that pays off with a windfall. It can be so easy for your financial success to leak when you're dealing with more money than you're used to. And the beauty of a windfall is that some of those leaks can be allowed. A credit card late fee of $35 means something different to someone with a negative net worth than it means to someone with a large bank account or an income of $500,000 a year.

But it's still an unnecessary $35 to pay. One might not hurt. Twelve in a row might not even affect your day-to-day living. But when late fees set the stage for a philosophy where leaks are allowed, you can find yourself depleting your money supply unnecessarily, and without tracking your finances, you'll have no idea it's happening until it's too late - when you can no longer afford your mortgage payments from  savings and bankruptcy looms.

Have you ever received a windfall? What tips work for you? What advice do you have for holding onto your windfalls, unlike the Bluth family?


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