Dealing with a windfall:  Go slowly

by Don Kuehn

All right, admit it. You buy lottery tickets, don't you? Somewhere in the back of your mind you secretly believe you could be the one to hit The Big One. Wealth and riches beyond belief fall into your lap just by picking a few numbers and getting lucky.

Fahgettaboudit! Prince Charming isn't going to whisk you away on a big white horse, you're not going to make it on the Senior PGA Tour, and you're not going to win the lottery.

But one day you just might have a significant amount of cash at your disposal either through an inheritance, severance payment, retirement plan payout, tax refund or insurance settlement. In fact, over the next 15 years, Americans will harvest an estimated $17 billion in just these kinds of windfalls.

So, after a life of making it from paycheck to paycheck, what do you do when confronted with a few thousand--or several hundred thousand--dollars in "free money"? Most experts will tell you not to rush into anything. Don't put your new-found riches in your checking or savings account. Go to your bank and buy a two- or three-month certificate of deposit (CD) while you develop a financial plan and make reasoned decisions on spending, investing or saving the money.

As with any financial decision, each person's circumstances and investment temperament will be key factors in deciding whether to save the money and watch it grow, to pay down debt, or to spend all or part of the windfall on necessities or once out-of-reach luxuries.

Depending on the size of your bonanza, you may have several options to consider.

Cover the fundamentals first. If you don't have a personal investment portfolio, this may be the perfect opportunity to get started. This is fundamental. Regardless of what you believe about the future of Social Security or your employer/state pension plan, every individual should have personal investments to supplement retirement. Use those few months while your cash is stashed in the CD to learn as much as you can about mutual funds and how investments work.

When your CD matures, buy a few good no-load funds and pledge to keep adding to them on a regular basis. If the amount you have to invest is large, consider dollar-cost averaging (investing a set amount at regular monthly intervals) and asset allocation models appropriate to your situation.

This might be a perfect way to get started on a Roth or traditional IRA, to open an Education IRA as a college fund for your kids or grandkids or to replenish your emergency fund of three to six months of living expenses.

Pay off debt. If you are up to your eyeballs in debt, a windfall might be just the tonic to cure your ills. Paying off high-interest credit card bills or other installment debt is the smartest thing you can do to improve your financial health. I have written about the traps of credit card debt in previous columns, but if you can pay off a card balance with an 18 percent annual interest rate, you've just made five times the return you could get by putting the money into a savings account.

When deciding what debts to pay off, the general rule of thumb is to pay the highest-interest debt first (usually credit cards). That frees up money to accelerate the payment of your next-highest interest payment, and so on.

Spend wisely. The third, and most tempting option, of course, is to spend every last dime. Money shouldn't be thought of as a convenient way to keep score; the idea is to use it as a means to enjoy a full, rich life. Treat yourself to the things that make life fun and worth living. If you really want that new computer, a trip to China or a new car, go ahead. If this new-found cash lets you make a down payment on a new house, congratulations. If it means being able to do good deeds, that's great.

Remember, wherever it came from--inheritance, tax refund, severance payment or salary--it's ALL "real money." The unprecedented rise of the financial markets over the past several years may inspire confidence, but markets that go up also come down. Treat your assets with caution and keep your eye on your financial goals.

Once you have put the essential building blocks in place to secure your future, the only reason to have money is so you can do the things that you have always dreamed of doing. And hey, don't feel guilty about it.

Author Stephen A. Pollan embraces that philosophy in his best-selling book Die Broke (HarperCollins). Wealth, he says, is to be spent while you are still alive, either on yourself or on your loved ones. Forget about leaving an inheritance to your relatives. If you want to take care of them, give gifts while you are around to share their enjoyment. Leave behind just enough money to settle your estate and get on with living your own life to the fullest.