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How to go about managing windfall income? - Outside View by PersonalFN
 
 
How to go about managing windfall income?

All of us desire to be blessed by a windfall income someday, so that we can go on a shopping spree and / or our favourite holiday destinations. But let's apprise you that astute use of such an income can help you to become even richer. You see, allowing your money to work for you can enable you to live life more comfortably.

Windfall income could arise out of lottery winnings, lawsuit judgements, large inheritances, divorce settlements, insurance settlements, or retirement packages amongst a host of other reasons; but if you don't deploy this pleasant surprise judiciously, it might get extinguished before you even realise it.

Here are a few guidelines which can help you to appropriately manage your windfall income that you have earned through your hard work or merely by luck-

  • Set a Cool Down Period: Most people can get overwhelmed by a windfall of money. They might be tempted to spend their fortune recklessly on expensive trips, luxury cars or extravagant things. Gaining a windfall might also lead you to impulsively lend money to your friends and relatives who are in need of financial help, but later might be incapable of repaying your loan. Or worse, you might land up investing in some dubious investment strategy which might never earn you any returns. Setting a cool down period (say 1 year) ensures that the person who has come in possession of the wealth takes time to think about how to use it, and avoids the initial risk of spending or investing it out of excitement. So initially, the money can be held in money market instruments or public sector bank savings account or a one-year Fixed Deposit (which provide capital protection and liquidity, albeit you would derive low real and tax-adjusted returns) until the decision to use it wisely is taken.

  • Boost Emergency Funds: In this world nothing is permanent or guaranteed. It is important to have a contingency fund created. And so, in case if you haven't created a contingency fund, which takes care of at least 6 months - 12 months of your monthly expenses by having deployed money in a separate saving bank account or liquid fund, you must do so first with the help of windfall gains.

    You see, this will protect you in case of any unforeseen contingencies that might weaken you financially (such as loss of job, decline in the monthly income and so on). Therefore the newfound wealth will play a crucial role to help you on your rainy day when the need arises.

  • Meeting Your Insurance Needs: Now-a-days, all of us face a lot of stress and tension. We are more vulnerable to physical and mental disorders as compared to our previous generations. For these reasons, it is very important to have an adequate health and life insurance. If you are not adequately covered, then use the windfall income to buy/increase your insurance cover. But again here while indemnifying the risk to your life and health be careful about the policy you buy and ensure that you insure yourself with an optimal risk cover.

    Also, in case you plan to use your newfound fortune for purchasing expensive jewellery, artefacts, property etc. you will also need to buy specific general insurance policy(s) covering such assets, which could indemnify risk from fire, flood, theft etc.

  • Reduce (or Remove) Debt: In case if you have any debt lingering around, the windfall income should be used to pay off your debt and financial obligations (such as credit card loan, personal loan, home, business loans etc.), especially the ones that bear very high interest rates. Removing or reducing the extent of your liabilities must be among your top priorities when you plan to utilize the windfall gains. This would help you to boost your financial health and meet other financial goals.

  • Prioritize Goals and Boost Them: All of us have certain life goals. For Instance, to have a comfortable retirement, to educate children in the best school and college, to purchase a dream home, a car, and so on. In most cases since it is challenging to meet all these goals with windfall gains, it is imperative to prioritize goals as certain goals may be important not only financially but perhaps even emotionally, such as a transferring a portion of your money to your parents and taking regular holidays with your family or setting aside money for daughter's wedding. You see, the contributions for meeting these goals can be made or enhanced at this time.

  • Investing: As said earlier, make your money work for you and tread on the path of wealth creation. But while you do that, be careful of where you are investing and refrain from getting caught in a hype, exuberance or what your friends and family have to say. Instead, undertake solid fundamental research and invest in asset classes and investment instruments therein following the appropriate asset allocation meant for you.

    Although your risk appetite might increase with a windfall income, you must observe caution while determining your asset allocation. If your present investments are not generating enough returns to beat the inflation, you can consider investing your newfound wealth in assets that will enhance your returns relatively and mitigate the investment risks through diversification. You should also consider the tax angle while investing. If you endeavour to reduce your tax liability then it would be prudent to invest in tax-efficient instruments. And mind you, it is not only financial investments you must look at, but could also focus on personal investments such as educating yourself by enrolling for post graduate executive programmes or workshops that can help enhance your skill set. This would increase the probabilities of securing higher paying job opportunities and job security.

    Estate planning: Last time we wrote to you about estate planning, this shouldn't be ignored in case of windfall incomes. After all we want our money invested wisely - both in physical and financial assets - to be inherited by the people whom you want them to be transferred to in your absence.

  • Don't ignore taxes: In case of windfall income from sale of property, lottery winning, gifts and large inheritance; please do not ignore your constitutional duty of paying tax. Of course you can use the provisions of the tax laws to save taxes by planning your transactions well, but ensure that you discharge this legal responsibility rightly and consider it as a moral responsibility too.

  • Spending Money: Yes we recognise that you might also have a few personal wishes, which you dream to fulfil apart from family responsibilities. You deserve to spend a small portion of the windfall income as you wish so as to enhance the quality of life. For example, you can decide to spend 2% of your inheritance income on taking a trip to your desired holiday destination. You may also choose to donate some part of the funds for a worthy cause.
One thing you must surely avoid is asking for tips from friends and relatives for managing your bonanza. Every person has different goals and risk appetites. They might have a different view of living life as well. It would be more prudent to seek help from certified professionals who can advise you regarding suitable investment opportunities which suit your risk profile and which can contribute in meeting your financial goals as well. This will enable you to make the most of your windfall in a tax efficient manner.

PersonalFN believes that earning windfall income becomes a reality for a very few individuals. This gush of money should be spent and managed wisely as you don't want to remember this once in a life time opportunity as a bitter-sweet experience.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

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