How to Financially Manage Sudden Wealth

So, you’re anticipating sudden wealth.

Maybe this windfall will be from a lawsuit settlement, business sale, stock options or an inheritance. Although each form of sudden wealth has unique financial, tax and legal quirks, all forms of sudden wealth share some common characteristics.

I’ve been working with sudden wealth recipients for over 25 years. Here’s what you need to know to financially manage sudden wealth.

Sudden wealth is different.

As much as you might like to think sudden wealth that comes overnight is the same as gradual wealth built over decades, I can tell you that after working with hundreds of windfall recipients, it’s not.

If gradual wealth is a smooth escalator ride that can take decades, sudden wealth is a rocket trip straight to the top in seconds. Your financial circumstances change overnight, and you have no chance to adapt or to grow. To make matters more difficult, you’re often forced to make immediate financial, legal and tax decisions that can have permanent and dramatic consequences.

So, how can you turn this one-time windfall of money into something that can provide lasting financial security and improve your life for decades to come?

With a lot happening at once, you need to lean on solid financial principles —building the right team to help guide you, slowing down, learning how to say no to friends and family, protecting your new wealth, setting spending limits and staying on track, among others. But where should you start? I suggest starting with the most important asset you have in this process: your mind.

One of the biggest mistakes I see with sudden wealth is that it is not valued as highly as money that has been earned. Psychologists call this mental accounting, and as a sudden wealth recipient, you need to understand how this limiting money belief can cloud your judgment in making good financial decisions.

The consequences of valuing a windfall differently than earned money can be dramatic. Sudden wealth recipients are inclined to take more risks with the found money, give it away more freely and spend it faster and more lavishly.

One client who received a large wrongful death settlement check called it “funny money” because he couldn’t get his head around it, even though he lost a family member and spent years battling for justice. Another client received an inheritance and told me the numbers in her bank account felt like “Monopoly money.” If you think of your sudden wealth differently or somehow worth less than the money you’ve earned, the financial consequences can be disastrous — the money that came overnight can disappear just as quickly.

How can you put more value and gravitas on sudden wealth? Here are three ideas:

1. Become aware. Sometimes it’s as easy as becoming conscious of our tendency to put more weight on money we’ve earned and less weight on money we’ve found. After having this conversation with clients, I often see a shift in how clients will talk about their sudden wealth and their plans for it. Some have even laughed at how illogically they viewed their money and are grateful for their new financial understanding and appreciation.
2. Get perspective. This is an exercise that blows minds. Calculate how many hours you would have to work to earn the sudden wealth. For some, it would take hundreds of years. Or, the next time you are about to make a purchase, calculate how many hours you would have to work to buy it. Then ask yourself if you’d really spend the money if you had to earn it.
3. Create a play money account. When all else fails, embrace mental accounting! Take a small amount of your sudden wealth, an amount you can risk losing, and put it into a separate account earmarked as mad money. Put the rest of your sudden wealth in different financial accounts. If you want to undervalue your money, at least put a cap on what you’ll undervalue.

Want to turn your sudden wealth windfall into lasting wealth? Follow the tips above and slow things down. Make only those decisions you must make and hit the pause button on major purchases and life decisions until you are ready.

Remember, sudden wealth is an opportunity to improve your life. Find a CFP® professional today to help you make the most of it.