Winning the lottery is a universal fantasy, at least for those who have never been independently wealthy. Ask anyone what they would do with their winnings, and they’ve likely thought about it. Most people dream about purchases—a new car, a bigger home, an exotic vacation—or paying off their debts. Few say they would invest their winnings in a diversified portfolio of assets that’s aligned with their financial goals. After all, winning the lottery is highly unlikely, so developing a practical plan for a windfall of cash doesn’t seem necessary.
In reality, people come into sudden wealth in a variety of ways that don’t require a winning lottery ticket. Whether it’s through a substantial inheritance, the sale of a business, a successful IPO, or signing a lucrative employment contract, the question remains the same—what’s next?
Newly wealthy individuals often don’t know what to do with their first payout, making them susceptible to the wrong people, poor advice and bad financial decisions. Anyone experiencing sudden wealth should follow a few basic guidelines to avoid making impulse or emotionally-driven decisions that can quickly backfire.
Slow Down, and Let New Reality Sink In
Natural human instinct tends to favor spending newly acquired wealth, especially if the recipient was previously financially-strapped. However, this is also the time when long-lost family members and friends come around asking for handouts or loans, often proposing new business ventures. The unprepared are more likely to agree, only to later find themselves committed to unfortunate decisions.
The excitement surrounding sudden wealth often results in impulsive investing. People can easily become the victim of predatory behavior by those who come out of the woodwork. The newly wealthy would be well advised to slow down—not to shoot first and ask questions later.
Instead, hit the pause button. Before making any extravagant purchases or sharing the wealth with family and friends, the newly wealthy individual should spend a few months getting used to the idea of having money and what it means for the future. This usually requires a shift in mindset, which can take just as long as—and in some cases, longer than—developing a formal financial plan.
Assemble a Team of Trusted Advisors
It may seem like overkill to hire a full team of professional advisors but doing so can have long-lasting wealth preservation benefits—especially if the recipient has limited experience or background knowledge in this area. Initially, a well-rounded team may include several specialists:
• An attorney who can establish necessary legal entities to hold assets that protect against predators;
• A CPA who can advise on tax consequences of the windfall and ongoing tax return preparation;
• A wealth manager who can provide cash management solutions, develop broad investment strategy, evaluate unique opportunities, implement the investment program, and prepare comprehensive reports;
• A banking solution for everyday activity, transfers, and convenience.
While someone selling a business or property may already have relationships with various professionals, those who are truly new to wealth may be starting from scratch. When this is the case, they should spend time interviewing several professionals in each category to find a team that can be trusted to act in their best interest. Questions like, “are you a fiduciary?” and “how are you compensated?” often reveal potential conflicts of interest that can discredit the professional’s advice.
Have a Plan for When the Money Arrives
While many people might assume that taking their check directly to the bank is the safest course of action, doing so can present unintentional risks if the deposit is substantial. Since the FDIC only insures deposits up to $250,000, anything over the limit is at risk if the bank’s financial health declines.
Instead, a better course of action may be to temporarily invest proceeds in high-quality, short-term, liquid securities such as Treasury bills, short-term municipal bonds, certificates of deposit, and money market funds. These types of investments typically hold their value relatively well regardless of the prevailing market environment while generating a modest stream of income. Liquidity and safety are paramount during this initial phase.
During this time, an advisor team can help the client decide whether dividing assets into trusts, partnerships, property, and other protective financial vehicles is prudent. For example, a trust can become a powerful stop sign when the newly wealthy individual is faced with requests for financial assistance. Establishing a trust with distribution standards and a trustee to enforce those standards gives the individual a legitimate reason why they can’t immediately write a check. Instead, the trustee is obligated to evaluate the opportunity and advise the individual accordingly.
Develop a Long-Term Wealth Management and Investment Plan
The newly wealthy may need help with day-to-day budgeting and cash flow needs as well as identifying and planning for future financial goals A wealth advisor can model various cash flow scenarios to determine how much the client needs to live comfortably without overspending and depleting their wealth.
Once a financial plan has been established identifying the client’s future financial goals—for example, paying for children’s educational expenses, maintaining a certain lifestyle through retirement, or transferring wealth to the next generation—their wealth can be divided into buckets and invested in a diversified mix of assets aligned with each goal’s target rate of return and time horizon.
Initially, it’s best to start simple by focusing on traditional investments such as stocks and bonds. Once the client becomes more comfortable with investing, hedge funds, private equity, and other alternative investments may be appropriate. Remember—portfolios aren’t built overnight. New investors often need to slow down and view wealth management as a marathon, not a sprint.
While individual situations will certainly vary, the right team of advisors can often save the suddenly wealthy from making detrimental decisions with their money. Wealthy individuals often need sophisticated legal, tax, and financial advisors to build a cocoon or protective shield around their family and assets. Though the process for getting organized may take several months, the outcome will almost certainly be beneficial in the long run.
Barry Berlin, CFA, is a managing director and senior relationship manager for CIBC Private Wealth Management in Atlanta with more than 40 years of experience assisting high net worth families and their related interests.
Cathy Schnaubelt, managing director and senior wealth strategist for CIBC Private Wealth Management in Houston with more than 35 years of industry experience, is responsible for providing integrated wealth management solutions and comprehensive estate and financial planning services to high net worth clients.
