Windfalls: To Save or to Spend?

By Evor C. Vattuone, CFP®

During one of my few quiet moments after the kids were asleep, I came across a TV show about lottery winners and what they did with their winnings. As I watched, I saw the winners tour massive new vacation and second homes, consider luxury purchases, and struggle with their new realities. I found myself getting envious of their easy wealth, until I was reminded of an issue that we see in our offices time and again. We call it “the problem of abundance,” or in the parlance of behavioral finance, Sudden Money Syndrome (SMS).

It’s All About Perception

SMS is not restricted to lottery winners, and the amount of money is oftentimes irrelevant. SMS can be born from various sources, such as an IPO, large tax return, unexpected inheritance (small or large), employment bonus, or even cash gifts collected during holidays or birthdays. The feelings and subsequent outcomes are the same, and come from the sudden transition of not having spendable cash to having a seemingly large amount.

We also frequently experience the opposite end of the emotional spectrum after we’ve spent our last penny, or more! Also commonly, once the amount falls below a certain milestone we have in mind, we panic. For example, a $200,000 windfall, after we have spent a large chunk, now has dwindled to $9,000 within several months. This wakes up many “lucky ones” late at night with worry. The landscape of future expenses may still loom large, even after the money has been depleted, such as when we’ve committed to a home remodel, a nice party, and an extravagant summer vacation yet to come. This very common scenario tends to cause huge amounts of stress, and we start to sense the “I was better off before my sudden money” type of feelings.

What Should You Do? Know Thyself!

We’re often asked, “What do I do with this money?” or “How do I optimize it and make it work for me/us?” Sometimes we’re told: “I’d like to take most of this money and put it into a new home or pay off my mortgage, then invest a small part because I don’t want to risk it in the market.”

After a windfall is received, what matters at first isn’t so much what to do—it’s what not to do. Simply put: Do not do anything! Put the money into a savings account, and don’t even look at it for a few months. Then start to think about what the windfall means to you. If it means paying off a high balance on a high-interest credit card, then think before you pay it off and honestly realize why you racked up all this debt to begin with. People often don’t realize that their own behavior is the reason why they struggle financially. Many of us don’t take the time to consider, “What will this decision do for me three years, five years, and 30 years into the future? And have I really considered all my options?” Ask a qualified financial advisor who has your whole financial picture in mind before spending a dime.

We always go through a goal-setting and motivations discovery process with our clients before dispensing financial advice. Knowing what drives us (i.e., our motivations) as to what to do with the money is key to making good decisions. We often ask “Why?” in this situation and “How will it look three years from now?” to help our clients form a vision of their future selves. Oftentimes, paying off a mortgage, doing the remodel, or buying a new house is exactly the thing that is least important.

Commonly, when we receive a windfall, we don’t think through the details of our decisions. This is almost a certainty with home remodeling. As an advisor with over 20 years of experience, I almost always add 50% to 100% to a client’s remodel estimate—sometimes more if I know the client really well. Not only do most of us not understand what we really want from our remodel, but we also haven’t considered that contractors most certainly do not either! Contractors will quote a job to a level of completion and/or costs that sometimes fall far short of what we would consider complete—leaving out upgraded fixtures, for example. They also never will include the “extras” for a remodel, such as increased property taxes, new towels or sheets, new furniture to go along with the remodel, new carpeting, or even upgraded energy-efficient light bulbs! These extras really add up and can deplete an inheritance by more than 100% in the end.

Act Accordingly

So what do you do? Spend or save? A good general answer is to do both after you’ve done nothing for a few weeks or months. To be safe, you should apply your “retirement savings goals” to windfalls. For example, if you are targeting a 15% annual savings rate for your household and you earn $100,000 per year, that’s $15,000 annually. If you receive an inheritance of $100,000, try to save 15% of that at least. This leaves $85,000 for the remodel. Most financially successful people save half of their windfalls (after taxes are taken out if it’s a taxable sum).

To Be Remembered

  • When you receive a windfall, do nothing.
  • After doing nothing, think about what you really need, then want.
  • After considering the above, try to create a vision of your future self, still having the windfall, in whole or in part, and having converted it into another possession or experience. The real poverty of typical families is found neither in their low (or high) income nor in their costly essential expenses, but rather in not understanding their cash flow.
  • Regardless of income level, overspending causes poverty. Saving and budgeting produces wealth.