Sudden wealth syndrome: Tips for avoiding potential pitfalls

Posted by on August 15, 2013 @ 2:30 pm in Personal finance

Most of us are used to earning a salary and building retirement savings gradually, over time. It is a deliberate and steady process. Sudden wealth, on the other hand, means receiving more money than you’re used to being responsible for—all at once. For some that could be $50,000. For others it could be $50 million.

The first time I witnessed what’s sometimes called “sudden wealth syndrome” was several years ago, when a friend* came into a large amount of money through her husband’s abrupt business success. She (and he) had never dealt with significant wealth before. The rapid change in their economic status was a source of euphoria for both of them, leading them to quickly embark on an extravaganza of elaborate parties, jewelry purchases, and exotic vacations. There were suddenly private cars with drivers, maids and butlers, and personal chefs. But no savings.

Fast-forward several years to the financial crisis, his unfortunate business failure, and the implosion of their newly minted hedge fund investments. My friend was suddenly firing the household staff, listing the vacation home, and visiting the pawnshop to sell her jewelry. There was even talk of a loan from their families. It was very painful to watch. Then one day my friend came to me to ask for help. Apparently, she had no idea how much they were spending.

This is where the phrase “sudden wealth” begins to draw negative connotations. While at first blush sudden wealth might appear to be a source of joy, rather than a problem, what it actually means is a swift and unexpected financial change that takes you out of your comfort zone, sending you on a journey for which you’re emotionally and practically unprepared. And when you’re emotionally and practically unprepared for sudden wealth, it can do more harm than good.

We’ve all heard about lottery winners, but in practice sudden wealth can come from a number of sources, including:

-     Inheritance.

-     Lottery winnings.

-     A divorce or lawsuit settlement.

-     Sale of a business.

When a person comes into sudden wealth (again, whether it’s $50,000 or $50 million), and they’re unprepared, they can wind up squandering the money as well as complicating their lives. Enamored by the idea of suddenly being able to afford all the things they’ve ever dreamed of, they impulsively embark on a spending spree—just as my friend and her husband did. But these adventures typically don’t end well. According to one study, the rate of lottery winners filing for bankruptcy within five years of winning is double that of the general population.  Sports Illustrated has also reported that 78 percent of former NFL players are bankrupt or experience extreme financial difficulties within two years of their retirement.

So how should you deal with sudden wealth in a way that allows for some fun, while also planning for the future? Because sudden wealth can come from many different sources, there isn’t one single solution. But there are some common principles to keep in mind:

-     Expect change. Although sudden wealth might seem like a good problem to have, it can also mean a huge amount of stress as you face new financial decisions. Although your pocketbook has changed significantly, you haven’t changed as a person. Your dreams, goals, and personal values remain the same. Remain true to them.

-     Take your time. Sometimes, financial problems can arise when you think you need to act quickly with your newfound wealth. Purchasing lavish gifts, taking expensive vacations, and buying an exotic and trendy new financial investment can be a bad idea. Instead, consider placing your money someplace reliable, like a money market fund, and take your time to plan your next financial step. This will allow you to really focus on your goals, expectations, and long-term planning.

-     Develop a strategy. It’s likely that you’ll need to obtain an investment advisor to help you, if you don’t already work with one. As you strategize, think long-term.  As you invest, remember your investment principles. You’ll also want to consider estate planning opportunities—such as putting aside money for your children and grandchildren.

-     Invest in yourself. Take some time to enhance your financial education. While you may be working with an advisor, also study the issues yourself. You can do this by reading, taking a class, and talking directly with your advisor. Investing in your own financial education will allow you to be actively engaged and well-informed in your financial decision-making.

-     Take care of obligations first, play money second. Regardless of the source of your sudden wealth, you’re going to want to find out about any tax obligations. If you have any outstanding debts, pay them off.  Then, if you have leftover money, you may be able to set aside a small portion as “mad money.” Create a wish list, and brainstorm everything you would do, if you could. Then prioritize, and choose just one that is within the budget that you set.

-     Consider charitable giving.  If you’re charitably inclined; for example, you’ve always dreamed of making a gift to your university or to a nonprofit organization, now’s a good time to lay your plans. A charitable gift can not only help you reach your personal objectives but also provide an income tax deduction.

-     Review again after a year. One year after coming into sudden wealth, it makes sense to review the situation to evaluate how you’ve saved, how you’ve spent, and how you’ve shared. Then, make any adjustments in your long-term plans, and continue to review every year.

Sudden wealth means that you can afford things now that you couldn’t before. It can be a tool to help you achieve your dreams and goals sooner than you anticipated. It can even help you help those around you and allow you to achieve your charitable-giving objectives. But to do this, you must stay true to your personal values. It takes discipline, planning, and guidance. But if you invest the time and effort necessary to manage your sudden wealth, the journey will be all the more rewarding.

Notes: All investing is subject to risk, including the possible loss of the money you invest. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.

* Details of this example have been changed to protect the identity of Ms. Hammer’s friend.

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