There are four main events that create a financial windfall: sale of business, lottery win, inheritance, or high net worth divorce situation. Many people who come into a large sum, say $5 million dollars or more, may not have the necessary experience to handle this sudden influx of capital. In fact, according to the National Endowment for Financial Education in the U.S., it is estimated seven out of 10 people who unexpectedly come into large sums of money will lose it within seven years.
What do you do if you come into a windfall? Turn to a financial professional you trust before spending the money. If you don't already know one, or you want a second opinion, then an objective, fee-for-service professional who does not have a financial stake in your investment choices is an ideal person to approach. Interview at least three, understand what each professional does and what they do differently to determine the right fit for you and your needs.
For us, managing our clients' financial windfalls to endure is a five-step process.
Step one is setting goals with a client, both personal and professional. Questions to consider are: Do you still want to work? Can you afford not to work? What do you want to buy with your new-found capital? What legacy do you want to leave behind, financial and otherwise?
Shortly after receiving their windfall, it's not uncommon for clients to find themselves wanting big-ticket items, like a new car or new property. Having clients understand the financial impact of those large-ticket purchases is crucial. In these cases, we give our clients a 'reality review,' showing them how much the items will cost to buy and maintain, and how much they will have left over. Many times, after seeing the financial impact, we have seen clients pare down their want list.
We still encourage clients to have some enjoyment with this new-found money. Allocating up to 5% of the new funds for "play money" is a good rule of thumb.
Step two is a sensitivity analysis. This is a projection on what the remaining capital can earn in terms of income to support the lifestyle. The sensitivity analysis provides a client with their capital balance over the next 20 to 30 years, based on conservative assumptions.
It is not our role to tell a client what to do, but to provide good advice. We run enough scenarios, with a variety of parameters, to give the client perspective. We also tell clients that have a financial windfall, that if we do not properly and thoroughly plan this out, the odds are high they are likely to run out of money before they want to.
And that's where step three comes in: planning and projections.
In these situations, family, friends and others may look to a client for financial help, and they may also want to donate a portion of their funds, so it is important to establish how much money will be spent on philanthropy. Putting a plan together with the client does not happen overnight, but is a process well worth the time.
Once their goals are established, the plan is drafted and the projections are created.
Step four is implementing the plan.
Step five is monitoring the outcome. This does not mean we watch every penny our clients spend. Say the cash inflow for a client will be a half a million dollars a year, at the end of the year we will know whether they have spent within that because either they are on track, or they will have eroded their capital.
We also monitor if the investment return met the projection. If the goal has not been met, we look at what actually happened and what caused the deviation: poor investment returns? Over-spending? Then we revise the plan for the next year. The plan is never meant to be done and just put away in a drawer.
These five steps are the key for maintaining a quality standard of life and having your windfall meet your short, medium and long-term goals. Most importantly, they ensure you are one of the 30% who have a positive outcome with their windfall for the long term.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.