When You Receive A Windfall, Treat It Right

by Silicon Valley Blogger on 2011-04-1810

Have you ever received a windfall? This would be money that lands on your lap unexpectedly, putting a grin on your face. It’s the opposite of what normally happens to us regular folks who often come across unexpected bills and costs that throw our budgets out of whack. Ever notice how easy it seems for bills to just come out of nowhere and pile up on your desk? And how it hardly ever happens that you chance upon a bunch of money with no strings attached? What I’m saying is that it’s much easier to become a target of a debt collector than it is to be the lucky recipient of free cash. That’s just life.

What Is A Windfall? Plus Human Behavior Towards Easy Money

Windfalls come in a few flavors such as an inheritance, tax refund, a lucky win (somewhere), a generous gift, a raise or a work bonus. Now here’s the thing. I believe that just as we all need an emergency fund to handle unexpected costs, I daresay we also need an emergency plan of some sort in order to address windfalls. People these days are quick to act on this free money without a plan, and many times, it becomes just plain disastrous to be holding on to a big chunk of change when you’re not prepared to deal with it. As easy as money comes in, it can also easily leak out. Just ask a lot of lottery winners who go broke in record time.

I actually have heard and read about what sometimes happens when people receive windfalls. Behavior towards free money can vary depending on your financial standing and situation. This is just my analysis, but I believe that those who tend to fall in the extremes of the economic spectrum may tend to be more rash about money. Why? Let’s see the cases:

Do you have a lot of money already? I would presume that rich people think of windfalls as pocket change. When the cash is not a big enough amount to make a dent in their lifestyles anyway, they’ll simply use that money like they do pocket change. They’ll spend it on something ridiculous and outrageous just because they can. Besides, amounts here are relative, especially when you think in terms of CEO bonuses.

Do you have no money at all? You’ll be surprised about this one. When people who are not used to having money suddenly get a whole lot of it, what do you think their reaction will be? Expect a lot of emotion and a lot of drama (good and bad). When you couple emotion with money, it can lead to a lot of fireworks (and maybe not the good kind). I have heard someone who was admittedly poor tell me that this is because those who lack money often feel like they need to “treat” themselves when they finally luck out a little. Can’t blame anyone who feels this way: feeling deprived can truly suck over time and feeling like you deserve a break now and then is natural human behavior.

So this leaves us with the need to try to prepare ourselves for those times when good fortune may smile upon us at some point. Have some kind of plan for the time when you may find yourself with sudden cash. Think twice before you implement the plan and if you’re going to get someone’s opinion, you better make sure they’re trustworthy.

Where Would I Use A Windfall Today?

Quite a long time ago, a money question came up over at Lazy Man and Money. It’s a three part series (Part 1, Part 2, Part 3) that asks what some of us bloggers would do if $50,000 just happens to fall on our laps.

Here’s what I said back then:

If I had an extra $50,000 up to $100,000 lying around, I’d probably use it to develop my business further. My spouse and I are both business owners so it would be great to be able to inject a little more money into our ventures. This would enable us to breathe a little easier and would allow us to stop worrying about financing. As another option, I would also consider adding this money to our second child’s 529 savings account. I believe that a lump sum investment can go a long way here because this kid is still pretty young. I’d be tempted to build a relatively more aggressive portfolio that included emerging market investments, REITs and US small caps for this purpose.

Well, a lot has happened since 2007, when I first wrote this about windfalls. For instance, the 529 account for my child has been taken care of, thanks to generous grandparents, relatives and Upromise! So today, I’d use a windfall of up to $100,000 to apply against my mortgage instead. We’re almost done paying it off and it would be absolutely wonderful if we can just get it over and done with. ;-) So if there is a spare $100,000 headed my way, it’s going to go to property payments. I doubt, however, that we’ll be the recipient of anything so desirable for a while.

There are also other great things I can think of doing with the bucks, such as earmark it for some home repairs for the next couple of years (invest in the house!), new furniture (it’s time for some changes) and most importantly, a new car (we’ve pretty much run our family van to the ground). Anything leftover can simply and quietly go towards our given asset allocation mix for our longer term goal of retiring early. What this demonstrates is that we all have competing goals for our money. In fact, if you give yourself a few moments to think about it, you’ll find that it’s pretty easy to think of things you can do with cash that you receive out of nowhere. It’s therefore important to prioritize your needs and wants pretty carefully before you go out on a spending spree. This is what I meant by having a financial plan in place before you go out and do anything with your money. It’s important to “sit on it” for a while whenever something changes for you on the financial front, especially if it has longer term ramifications for you and your family.

How Should You Treat A Windfall?

We are all at different stages in our lives but there are general guidelines you can use to figure out how to handle a windfall. In general, the best ways to treat unexpected money is to:

  • Use it to first get rid of your debt or to reduce your credit card debt.
  • Create an emergency fund by squirreling your windfall into highly liquid savings accounts or in a high yield free checking account.
  • Fund longer term financial objectives like the goals to save for college or to save for retirement.
  • Invest in an index fund.
  • Pay down your mortgage or other “good” debt.

What I would be very careful about doing? Buying an expensive big ticket item that depreciates in value very quickly ;). If you’re thinking of going down this path, make sure you can justify this move.

 
Created: June 4, 2007. Updated: April 18, 2011

Copyright © 2011 The Digerati Life. All Rights Reserved.

{ 8 comments… read them below or add one }

LB April 19, 2011 at 8:43 am

Love your article, that is exactly how I was thinking about extra money.

You see, I have recently come into a windfall of sorts and had to figure out what to do with the money. It wasn’t free money of course, because there are always some sort of taxes involved, but it is a chunk of money I never expected to receive.

I had planned on paying off debt (all debt) and going back to school if I ever received enough money, but now that the money is actually here, I am not doing that.

I have a decent paying part-time temporary job that is going to pay off my debt, a little slower than the windfall money, but none-the-less will do the same job. (I wouldn’t save THAT much if I paid off debt today then in a couple of months). Since I have the extra job, going back to school isn’t going to work until next year, so for now I am leaving the money where it is at. Next year I plan on taking it and putting it in retirement and if I need, paying off the little debt that is left. Then heading back to school for a tax break.

I am probably the most boring person I know, when it comes to money. I will be laughing at everyone around me when I retire comfortably :)

Squirrelers April 19, 2011 at 11:17 am

I think you touch on some really good points here. I actually had this random thought enter my mind, after hearing a story about lottery winners spending tons of money. I thought that if somehow $1 million came crashing down from the sky into my bank account, I’d spend 1% of it ($10,000) on pure fun, and apply the remaining 99% toward current or future expenses. Meaning to me, any and all debt elimination, plus saving for retirement.

Also, when you talk about emergency funds and “squirreling your windfall”, I can certainly appreciate those sentiments :)

Silicon Valley Blogger April 19, 2011 at 12:17 pm

@LB, that’s awesome. I think that when it comes to money, the more boring we are, the better! It’s when we start injecting excitement and drama into our finances that we get into trouble. Impulse control goes a long way! Thanks for sharing your story. :)

@Squirrelers, it’s funny because I always think that I’m so ready for a windfall! I don’t remember getting an unexpected one yet, but I have received a lot of help from my parents and grandparents while I was growing up. But I keep saying how my years and years of studying personal finance as a hobby and being a natural frugalist should prepare me for the time when that big one arrives! ;-) But if I were going to receive a windfall, may it be under happy circumstances (e.g. lotto vs an inheritance, for example).

ConsumerMiser April 20, 2011 at 6:51 am

SVB,

I enjoyed your article. I generally advise that a windfall should be used first to pay off bad debt (credit card, high interest rate loans). By paying off high interest rate debt, you save on the interest you were being charged on it. Second, I advise starting an Emergency Fund as you said. If you don’t have one, maybe this should be first before paying off debt. Third: Invest. Invest. Invest. Fourth: Think Long Term and Start or add to Retirement Savings. Fifth: Save for College. Sixth: Pay off your Car. Seventh: Consider buying something that will save you money like new energy efficient windows or how about an energy efficiency assessment on your house? New insulation? Energy efficient light bulbs? Eight: Consider a Home Improvement Project. Nine: Finance your Own Business. Ten: Pay Down or Off your Mortgage.

Now, it is not always easy to follow this advice. My wife and I are considering having an in-ground swimming pool installed if we receive an unexpected windfall!!! A swimming pool is probably the last thing we should do financially, although we are looking at the benefits and memories for the entire family that will be created and believe they will outweigh this terrible financial move. Buying a swimming pool is not a good investment and we know this going into it (if we actually buy one).

Kosmo @ The Soap Boxers April 20, 2011 at 8:35 am

The government hates me for the way I “stimulated” the economy with the economic stimulus payments. We dump the money into a 529. We didn’t need a big ticket item before we got the check, and the act of receiving the money didn’t create the need for an item.

50K now would be put toward a house. We’re outgrowing the current house and are slowly looking for something slightly bigger.

Luckily, neither my wife nor I have terribly expensive tastes, outside of relatively small occasional splurges. If I got a million dollars, I’d like to cut back to half time at work to focus more on my writing (and when I become a world famous writer, then I’d quit my day job.)

Stella April 26, 2011 at 3:47 pm

It’s always good to have a plan should extra cash come your way. Even if the amount is small, without a plan it tends to get wasted. For example: my Mom sent me a check for $300 for Christmas. Before I knew it, I had earmarked those extra funds for car repairs, some new boots, etc. When all was said and done, I probably had spent that money three times over in my head. Fortunately the car repairs weren’t necessary. ;) But you’re absolutely right about having a plan!

Eric June 29, 2011 at 9:34 am

Interestingly, I just had my 2nd ever real windfall. First was a bonus, 2nd was some money my mother shared with me from an inheritance she got. In both cases, the money went to savings. The first is STILL sitting in an account, 5 years later, and the 2nd allowed me to help out my brother from a rough situation. I have a plan…since I have no real debt except for a very low rate mortgage, the money goes into the bank….

Silicon Valley Blogger November 19, 2011 at 12:25 am

Note that this topic came about when a group of finance bloggers and I decided to start a new tradition where we wanted to address money questions which we receive from readers each week. This was a new venue where answers from the participating bloggers are compiled into a post to showcase the variety of responses we would come up with; we also wanted to provide different perspectives for the same question. Granted, we’re not professional financial advisers here, but what we offer are diverse replies according to how we would deal with a specific financial issue or question ourselves, if we were in such a situation.

You can check the first edition of What’s Your Money Question? over at The Sun’s Financial Diary, which covers a question along the lines of “where should you put your money?” Check it out and see what a slice of the blogosphere has to say!

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