Receiving a large sum of money can be life-changing—but without a plan, it can also be fleeting. Whether it’s an inheritance, a business sale, a bonus, or equity compensation, how you handle a windfall can make or break your financial future. To make sure you don't end up like the guy on TV who wins the lotto and ends up going broke within years, let's dive into the actionable steps you can take to grow and preserve your newfound wealth.
1. Take a Breather and Think Big Picture
Before making any moves, hit pause and reflect. This isn’t just another paycheck; it’s a significant amount of money that could change your life if handled correctly. What are your long-term goals? Maybe it’s early retirement, funding your children’s education, or even starting a business. Visualizing what you want out of life helps set a purpose for the windfall. Without clear goals, it’s easy to overspend or invest hastily. Start by thinking deeply about your values and how this money can align with them. The last thing you'd ever want to feel is regret after receiving a large sum of money because you forgot what was really important to you.
Sure, I'd like to say a financial planner can help you prioritize your goals and create a tailored roadmap, so you don’t miss out on this opportunity, but in reality, it doesn't matter if you don't know what's most important to you.
2. Tackle High-Interest Debt First
Debt, particularly high-interest debt like credit cards or personal loans, should be the first thing you address. Paying off debt can be an emotional and financial relief. Not only does this free up cash flow, but it provides a guaranteed return. For example, if you’re paying 18% on a credit card, eliminating that debt is equivalent to earning an 18% return—something hard to match in any investment market.
The quicker you knock out these obligations, the more room you’ll have to focus on long-term wealth-building strategies like investing or saving.
3. Max Out Tax-Advantaged Accounts
Tax-advantaged accounts like 401(k)s, cash balance plans, defined benefit plans, IRAs, and HSAs offer powerful growth opportunities that you can’t afford to ignore. By maxing out contributions to these accounts, you benefit from either current tax deductions (traditional IRA/401(k)) or tax-free withdrawals in retirement (Roth). For high-income earners, these accounts allow you to minimize your tax liability today and provide future growth that’s sheltered from Uncle Sam.
Another important reason for contributing to retirement accounts is the fact that they are credit protected, which we'll get to in just a bit!
4. Diversify Your Investments
Diversification is a fundamental principle of investing. You’ve probably heard, “Don’t put all your eggs in one basket,” and it’s especially true when managing a windfall. Consider spreading your money across different asset classes—stocks, bonds, real estate, and alternative investments—to manage risk.
Your goal is to reduce the impact of any single investment underperforming. More aggressive strategies might focus on growth stocks, while others may prefer stability with bonds. A diversified portfolio ensures you capture different opportunities while protecting your wealth from volatility.
There is a massive difference between growing wealth and protecting it, it doesn't matter whether you're managing $10,000 or $10,000,000 diversification keeps your investments from all moving in the same direction.
5. More Money, More Problems: Protect Your Wealth
As Biggie Smalls said, "Mo' Money, Mo' Problems." With more wealth, you become a bigger target for potential lawsuits and creditors. Asset protection is crucial. This might include purchasing umbrella insurance, which provides extra liability coverage beyond your homeowner’s and auto insurance. You may also want to look into trusts or legal entities that can shield your assets from unnecessary exposure.
Consider this: lawsuits are unpredictable, and having a comprehensive protection strategy can give you peace of mind. Don’t overlook the need to protect what you’ve worked hard for—it’s a necessary part of building lasting wealth and creating a legacy, if that's important to you.
6. Don't Forget Your Core Investment Philosophy
Just because you’ve come into more money doesn’t mean you need to overhaul your investment strategy. If you’ve been investing in low-cost, diversified index funds or ETFs, stick to that plan. Don’t get lured into flashy or speculative investments just because you have more capital. The principles of sound investing remain the same, you want a portfolio that can stand the test of time and serve your needs.
However, a larger windfall can open up opportunities for additional investments. Think about creating a “sleeve” in your portfolio for alternative investments, such as private credit, venture capital, or limited partnership real estate investments. These can offer attractive returns and further diversification, but they should be a small part of your overall strategy. These types of investments can be attractive but require proper due diligence.
7. Refresh Your Financial Plan
A windfall presents the perfect opportunity to revisit your financial plan. Are your retirement goals on track? Did your entire retirement goal change and now you're work optional? Do you need to adjust your savings or spending targets? A financial planner can help you revise your plan, ensuring that your newfound wealth fits seamlessly into your long-term strategy.
If charitable giving is important to you, now is a good time to incorporate philanthropic goals into your financial roadmap. Charitable donations can also provide tax benefits, helping to offset some of the tax burden from your windfall.
8. Resist Lifestyle Inflation
A windfall can make it tempting to splurge on a bigger house, a nicer car, or luxury vacations. While it's fine to enjoy some of your money, it’s important not to let lifestyle inflation drain your windfall. The key is moderation, as long as you've done the proper planning to know whether you can afford that new lifestyle then try to avoid it. This is easily the main reason why people end up going broke.
Avoid the trap of increasing your day-to-day expenses permanently. Instead, think of your windfall as a tool to achieve long-term financial security, not just a way to fund short-term pleasures.
9. Consider Giving Back- If that's important to you
Philanthropy can be both rewarding and tax-efficient. If you’re charitably inclined, setting up a donor-advised fund (DAF) allows you to make charitable contributions now and decide which charities to support later. DAFs offer an immediate tax deduction, and the money in the fund can grow tax-free until you distribute it.
Let's also not forget about foundations, ever wonder why most athletes and celebrities have a foundation? Sure, it's because they are passionate about a cause, but it also comes with its tax benefits.
Whether you want to support causes you’re passionate about or simply want to leave a legacy, charitable giving is a great way to use a portion of your windfall while minimizing your tax burden.
10. Consult a Financial Planner
Last but certainly not least, consulting a financial planner can help ensure you’re making the most of your windfall. From tax strategies to investment opportunities, a financial planner can offer tailored advice based on your unique situation. They’ll guide you through the complexities of sudden wealth and ensure your money is working toward your long-term goals.
If you're reading this and just have a question, or are simply looking for a recommendation, let's chat. At WealthBound Advisors, we specialize in optimizing your financial life based on your unique situation.
Disclaimer: This content is for informational purposes only. Consult with your tax advisor or financial planner before making any changes to your investment strategy.