Many people who find themselves with an unexpected large sum of money often lose it all. While money can solve many problems, it provides little value if its owners are not prepared to receive it. While this unexpected windfall may seem like a blessing it all too often becomes more of a curse.
Often those who find themselves on the receiving end of such bonanzas are woefully unprepared to handle such responsibilities. Most Americans have no formal written financial plan. In fact, according to CNN, 76% of all Americans live paycheck to paycheck. The thought of long-term investing is farther away in their orbit of priorities than the planet Mars.
In addition, due to the lack of effective financial literacy programs in most of our schools, the idea of compound interest finishes a distant last to the Home Shopping Network when it comes to allocating the majority of consumers’ funds.
Many have no positive financial role models and have misguided ideas how people create and sustain their wealth. Often false narratives replace data for making decisions on large sums of money.
According to The National Endowment for Financial Education, 70% of all lottery winners will lose it all in a few years. While this statistic is sad, it is not surprising based on the aforementioned points.
Often people that come into large sums of money use the funds to help a family member or friend start a business. This is often a very bad idea. According to Bloomberg, 8 out of 10 entrepreneurs who start a business fail within the first 18 months. In other words, there is an 80% chance by taking this action you will lose all of your money on this particular investment!
Many wealthy families believe they will be immune to this type of behavior when their children eventually inherit their wealth. It seems sudden wealth is a problem scanning all social classes. According to Reuters, 70% of families lose their inherited wealth by the second generation and a stunning 90% by the third! Hardly comforting news for the country club set.
A big factor in this mismanagement of wealth is the idea that purchasing depreciating assets is a sound financial plan. Buying an expensive sports car will give you a 100% chance to make no money at all. In addition, you will most likely lose 50% of your money and most likely much more than that.
Former NFL great, Warren Sapp, decided buying 213 pairs of Nike sneakers was a good way to diversify his investments. They were later sold at his bankruptcy auction for $6,390.
Finally, many take their new-found wealth and invest it in their home. While this is a much better idea than purchasing sneakers or cars, its investment merit leaves much to be desired.
According to the U.S. Census Bureau, the price of new homes have appreciated 1% a year from 1963-2008 when inflation is taken into account. There are better options for your funds than granite counters and in-ground swimming pools.
What is the solution to this problem? For one, doing nothing is a strategy and often the hardest one to execute. Stop and assess your situation before making any dramatic moves with your newly found riches.
Use this time to construct a team of experts. Find a good accountant, trusted lawyer, and a fee-only fiduciary investment advisor to help you avoid these common errors.
Don’t be rude to your family and friends, but tell them in very clear terms that you are not their personal Shark Tank. Mark Cuban can afford to lose some money, you cannot.
Create a budget to control your urge to increase spending beyond reason, by leaving aside a predetermined small percentage of your new funds as “fun money” to do with as you please. This will limit the damage and protect the majority of your principal.
Try to put a good portion of your funds in low-cost annuities, and retirement accounts in order to make the money less accessible to the whims of the moment. Like dieting, making things harder to get will cut down on your consumption.
While impulse control can be difficult, these strategies will help you to avoid blowing all of your good fortune. Wealth is not about what you have presently, it is about what you keep in the future to fund your financial freedom.