'Do nothing' is first step in avoiding the pitfalls of a windfall
One reason why windfalls are mismanaged is that they are often a bolt from the blue.
The New York Times
As sources of anxiety go, receiving a large sum of money must rank far down the list. But managing a windfall can be a stressful, hazardous undertaking.
While most people might be willing to take their chances, financial planners warn that great care must be taken to avoid financial and psychological pitfalls and ensure that a once-in-a-lifetime opportunity is not wasted.
Beneficiaries of a substantial payday, like a lottery winner, an heir to an estate or a shareholder in a company that goes public, may suddenly confront a wide range of choices that they scarcely could have imagined. That is why the first recommendation that planners make to recipients of a windfall — an amount far beyond what they are accustomed to, not any particular dollar figure — is often to do nothing.
"One thing we counsel people to do is live beneath their means," said Leslie Lassiter, head of the Los Angeles office of J.P. Morgan Private Wealth Management, adding that someone coming into a lot of cash should "park it in a very safe place so you can absorb it."
Timothy Greenleaf, managing director of Fairmont Capital, a Brea, Calif., private equity firm, has means that provide ample headroom to live beneath. Still, he found a wait-and-see approach useful when he received a sizable payment after the 2010 initial public offering of the Green Dot Corp., a provider of prepaid charge cards that he cofounded.
"Spend the day after your windfall like you spent the day before your windfall," he advised. "Many of the things you thought you wanted are going to seem less desirable. You can only spend a dollar once, so spend it wisely."
Greenleaf prefers not to say how many dollars he took away from the IPO, but he acknowledged that it was enough to make him, in the current vernacular, a 1 percenter. Based on his experience, he encourages windfall recipients to make estimated tax payments the first order of business and then to clear all debt off their families' books, including mortgages.
"You'll have greater comfort knowing your home is paid off and your loved ones provided for," he said. "You're going to feel good, but you're going to find it very sobering. You'll realize you have a lot less than you first thought."
Feelings of all sorts come into play when people come into money.
Some windfall recipients are "afraid to do anything and suffer from absolute paralysis," said Elizabeth Ruch, a financial planner at Waddell & Reed in San Diego. Others rush out to "buy that 96-inch TV or a new car."
IPO beneficiaries often fall into the spendthrift group.
Their attitude, Ruch observed, is, " 'I have slaved at this company and done without this and that. Now it's my time.' "
Lottery winners can also let windfall money slip through their fingers or have it pried loose.
They "tend to be the ones, because they didn't do anything to earn it, who give to people who appear out of the woodwork," she said. "They feel guilty not giving money to a friend or their brother."
One way to avoid poor decisions driven by emotion is to rely on professional advisers, like accountants, financial planners and lawyers, said Lassiter of J.P. Morgan. Apart from expertise in their fields that can help windfall recipients when it comes time to decide how to invest or spend their money, they bring detachment and dispassion.
Good advisers can say no to "friends and relatives with their hands out," she said. Perhaps more important, they can say no to the person who pays them.
"You want someone who's going to level with you and not sugarcoat it," she said.
Another reason that windfalls are mismanaged is that they are often a bolt from the blue. Someone who cashes in on an IPO may be in a better position than other recipients because IPOs tend to be carefully orchestrated, so the payday is expected.
"What we see in Silicon Valley is more premeditated windfalls," said Ronald Gong, managing director for family office services at Harris myCFO, a Palo Alto, Calif., financial planning service. "When you preplan, you have an ability to put a proper structure in place and set goals. It's the same race with a different starting point."
Technology IPOs are back in fashion; LinkedIn, Pandora and other Internet companies have sold themselves to the public in the past year, and Facebook has filed to go public this spring.
While Ruch said IPO beneficiaries were especially eager to break out their wallets after a windfall, Gong said the bust after previous technology booms had made this generation more cautious.
"The lesson learned in the last decade is that it's OK to take money off the table and be conservative," he said. "People get used to wealth gradually, not in one night."
By emphasizing patience and prudence, financial planners and Greenleaf remind recipients that a windfall really is a once-in-a-lifetime event. It may not allow them to change their lives radically, but if it is handled right, it can add security and comfort to enhance the lives they already have.