When faced with a windfall, individuals and families find themselves at a pivotal crossroads, where their decisions can shape their financial future in either a positive or negative light. A windfall, whether through a stroke of luck or the result of years of hard work, represents a profound shift in one’s financial circumstances. How this newfound wealth is managed can determine whether it becomes a blessing or a burden.
A striking illustration of this dynamic is evident in the findings of the National Bureau of Economic Research in the United States. Their research revealed that approximately 16 percent of NFL players, who often secure multimillion-dollar contracts, face bankruptcy within just 12 years of retirement. Similarly, tales abound of lottery winners who fritter away their newfound fortunes within a remarkably short span of time. However, it’s important to recognize that windfalls aren’t exclusive to professional athletes or lottery winners. As the 2021 Household Balance Sheet Report by Investor Economics suggests, Canada is on the cusp of experiencing a wealth transfer exceeding $1.2 trillion over the next decade due to intergenerational wealth shifts.
This underscores the idea that sudden wealth isn’t as rare as one might imagine. Furthermore, windfalls can emerge from various sources beyond substantial inheritances. They can result from selling a business, receiving a significant divorce settlement, or holding stock options in a thriving company one helped establish. What’s clear is that the majority of people lack the preparedness and guidance needed to effectively manage these substantial sums to their advantage, making it imperative to approach windfalls with a well-thought-out strategy.
Sudden Wealth Syndrome
Equally important, individuals are often unaware of the potential downsides. In fact, there’s a term for the challenges associated with financial windfalls: sudden wealth syndrome. This condition manifests when individuals receiving windfalls experience the opposite of the expected comfort of having additional wealth beyond their immediate and long-term needs. Symptoms of sudden wealth syndrome can include high anxiety, leading to feelings of isolation from friends and family, concerns about people seeking handouts, or stress related to a desire to help others as much as possible.
On the other end of the spectrum, sudden wealth can lead to over-exuberance and over-confidence, causing individuals to make poor spending decisions. Without considering the long-term implications, they might purchase high-priced items such as luxury cars, boats, and large homes, all of which come with ongoing upkeep costs that could become unsustainable over time.
Steps to Make Wealth Work for You
Certainly, in most cases, a windfall is advantageous for individuals and their families. The best way to ensure this is by seeking trustworthy, professional financial advice that establishes goals and develops a plan to preserve and grow wealth for the long term, potentially leading to its generational continuity. Moreover, an advisor, such as a certified financial planner (CFP), can act as a coordinator for other professionals, including accountants, lawyers, and insurance specialists, who are needed to execute a wealth plan effectively. It all begins with defining your goals for the wealth.
Are your objectives to secure an early retirement, create generational wealth for your descendants, make significant philanthropic contributions upon your passing, or provide support during your lifetime to witness the benefits of your charitable endeavors? Clearly defined goals serve as the guiding light for a comprehensive wealth plan designed to invest capital wisely, preserving and growing assets consistently over time to fulfill those objectives. Central to any effective plan is structuring your finances in a tax-efficient manner. For example, some entrepreneurs establish holding companies where profits from operating businesses can be retained and invested, taking advantage of lower tax rates on active business income.
This deferral allows investible wealth to accumulate more rapidly, though it is subject to higher taxes until it is eventually distributed as dividends to shareholders. Others seeking to support family and philanthropic causes may establish trusts, providing not only tax benefits but also addressing other concerns, such as how money is allocated to beneficiaries. The options are diverse, and sudden wealth offers individuals and families the opportunity to choose based on their goals and to follow a well-crafted roadmap. Even before engaging with financial professionals, taking a cooling-off period—time to reflect on your goals independently—can help you see beyond the initial emotions that can negatively impact financial behavior. Avoid making substantial purchases during this time. Instead, leverage various resources such as books or websites dedicated to financial literacy to educate yourself about the possibilities that newfound wealth offers and how to navigate its pitfalls. While in this reflection period, begin interviewing wealth professionals and explore financial support that aligns with your goals and personality.
Not all financial professionals are alike, with some being more skilled in managing high-net-worth clients with complex financial lives than others. Consider wealth professionals with designations, including portfolio managers who have a fiduciary duty to act in the best interests of clients. This is not necessarily the case with other advisors, who may have a less stringent standard requiring investment products to be suitable for a client’s risk level. A reputable wealth manager will construct a plan around your goals and manage the investment portfolio to serve those goals. Additionally, this advisor can connect you with other professionals, such as insurance, legal, and tax experts, or work with existing ones to ensure that all aspects of the wealth plan align toward your goals. Even with professional assistance, individuals should not absolve themselves of their financial responsibilities. At the very least, they should meet with their advisors annually while reviewing their finances quarterly. Understand the investments you own and why they meet the needs of your goals. Moreover, open communication with family members is crucial, particularly when wealth becomes generational.
Many individuals aspire to assist their adult children, but this should always involve planning with a wealth advisor to comprehend the impact of giving today versus as part of the estate. Often, this leads to family discussions regarding goals and philanthropy, creating a unified purpose for family wealth amid the emotional turbulence that windfalls can generate, as numerous studies have shown.
Take your time—between six months to a year—before making significant decisions. Do your due diligence, seek professional guidance, set clear goals, and then develop a comprehensive plan to achieve them. While it’s essential to enjoy your newfound wealth responsibly, whether with family or friends, do so within reason. The last thing you want is to become another statistic of mismanaged wealth.