A Good Problem to Have: What to Do with a Windfall

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I make a living by telling people how to get rich slowly. But every so often — admittedly a little less often these days — I hear from somebody who’s been able to do the opposite. They’ve actually managed to find sudden wealth, whether through inheritance, winning a prize, or selling a business. “What should I do?” these folks ask. “I’ve never had this much money before.”

Sudden money is a good problem to have — especially in a rocky economy like this one. But if you find yourself in this situation, you still have to make smart choices.

(MORE: How to Boost Your Income)

If you receive a small windfall of a few thousand dollars or less — through a bonus at work maybe, or by selling your old baseball cards — follow two simple guidelines:

  • Spend 5% of your windfall on fun. Treat yourself to a nice dinner or buy that collector’s-edition DVD set you’ve been wanting.
  • Use the rest to pursue your financial goals. Use the windfall to pay down your debt, to invest in your Roth IRA, or to save for your daughter’s wedding.

With small windfalls, it’s important not to fritter the money away. It’s very easy to spend on things that don’t matter in the long run. Instead, give yourself a small treat and use most of the money to better your financial future.

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But what if you get really lucky? What if you manage to win the lottery or you inherit a fortune from Aunt Mabel? With a large windfall:

  • Set aside enough to cover taxes. (You’ll be able to afford a tax professional to calculate this for you.)
  • Let yourself spend up to 5% on fun. Unless you have an iron will, you’re going to want to use some of the money to enjoy life. Do it. But be sensible.
  • Get out of debt. As unglamorous as it sounds, debt reduction is the smartest thing you can do with a windfall. This will free up cash flow so you’ll essentially enjoy a prolonged, time-release windfall.
  • Put the rest of the money somewhere safe. After paying down debt and taking a small indulgence, set aside any remaining money in a high-yield savings account or a certificate of deposit. Then, do nothing. Don’t touch the money. Give yourself time for the big emotions to pass.
  • Get professional help. While you’re waiting out your itch to spend, seek advice from someone who won’t profit from your newfound wealth. Find a good CPA or a fee-only financial planner who doesn’t sell investment products. With their help, map out a plan to use the money to pursue your financial goals.

You don’t have to look far to find stories of professional athletes and lottery winners who have squandered vast fortunes to end up broke. Instead of emulating the lifestyles of the rich and stupid, be smart. Follow the example of the quiet millionaires: Use the money wisely, and don’t change your lifestyle just because you have more money.

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