As far as financial issues go, experiencing an unexpected windfall or a sudden infusion of cash may sound like a solution in search of a problem. But as anyone who’s experienced something like this (at least on a large scale) can testify, it can be destabilizing to have your financial situation change quickly, even if the change is for the better.
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For one thing, many people really might not know what to do with a lot of extra funds, especially if their typical way of handling money is just to try to make it to the end of the month. As a result, they might feel paralyzed or anxious, or make bad decisions. Friends and family may start asking for financial help, which can be hard.
The situation is tricky enough that many find it difficult to handle well. In fact, when the amount of money is really large, it often goes quite poorly. One study showed that 70 percent of lottery winners go bankrupt within a few years.
Of course, not every financial windfall is as large or dramatic as a lottery win. Members of the military receive extra-large infusions of pay on a regular basis, due to combat pay, hazardous duty pay, and a slew of available bonuses. These large checks may not be as dramatic as an unexpected inheritance or a winning Powerball ticket, but experience shows that some of the same behaviors can occur, with service members tending to spend their earnings quickly on new cars, electronics, and the like.
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So, what do financial experts actually recommend to people who experience an inflow of money that’s more than they’re used to? Whether the source is a military bonus or Aunt Myrtle’s will, here are some guidelines.
- Slow down. If you haven’t got a plan, consider just “parking” the money in a simple and unglamorous savings fund while you figure out what to do with it. You have time. (But don’t leave it there forever!)
- Consider allocating some percentage of the windfall to a fun or “splurge” purchase, but be modest. Depending on the amount and your personal money situation, 5-20% of the amount may be reasonable. Stay at the low end if you have debt or little savings.
- If you have any high-interest consumer debt, such as credit card debt, a car loan, or medical bills, pay that off first.
- Your next priority should probably be creating or plumping up your emergency fund, though you can skip this step if you already have 3-6 months of living expense stashed away.
- Third on the list: max out your retirement savings for the year. For service members, contribute the max to TSP!
- Anything left? Homeowners could consider making any needed repairs or home improvements, but be cautious: not all will actually increase the value of your home.
- Although it may seem freeing, it’s probably not necessary to rush to pay off student loans or mortgages. These particular obligations are typically considered “good debt”: they are low interest and low risk. Your money is likely to be better used elsewhere. For instance, investing the same amount of money in a retirement fund will most likely yield you more interest than the interest you will pay on either of those type of loans.
- Depending on the amount of money, your personal financial situation, and your level of financial knowledge, it may be a very good idea to consult a financial planner or other financial professional. Of course, service members have access to financial assistance on base. If this is not sufficient or not available, consider hiring a certified financial planner. Many experts advise using a fee-only planner. To find one, search the National Association of Personal Financial Advisors (NAPFA).
Watch Wealth Building with Saving, Investing & Windfalls: https://oneop.org/event/28146/
References:
Dratch, D.(2011). 8 smart ways to approach a hefty windfall. Retrieved from http://www.bankrate.com/retirement/8-smart-ways-to-spend-a-hefty-windfall/
McGurran, B. (2017). https://www.nerdwallet.com/blog/loans/student-loans/ask-brianna-financial-windfall/
