There is no mental account for it, that money looks more of pocket money to you and you tend to spend it without thinking much. However money is money, no matter from where it came. It’s just different in your mind. Windfalls may not always come under pleasant circumstances. They may come at the time of great emotional distress, such as the death of a loved one in form of Insurance Claim, a divorce in form of alimony money or as a severance package.
Behavior towards Windfall Gains
Behavioral Finance is the area of finance that combines psychology and finance together and gives you an insight as to how a common man makes mistakes in his decisions from unexpected money received.
Lets imagine a scenario, which will give you a brief idea on behavioral towards windfall gains.
Imagine that you got Rs. 30,000 as your tax refund and you are more likely to be spending this money rather than the willingness you would have to spend from your salary.
Also imagine that some friend gave you Rs. 2,000 as cash who took it from you, didn’t give back to you and you also forgot about it. Will you even bother researching on what products can this money buy? In the same way, if you earn yourself an unexpected performance-linked bonus of Rs. 25,000; you will be more inclined to spend it on a holiday or for buying some item for the house such as LCD, microwave, jazzy mobile etc. Would you do the same thing with the money from your salary?
So the message is clear, don’t label money as ‘salary money’, ‘tax refund money’, ‘bonus money’ or ‘Gift money’. It’s just MONEY!
Implications of a Windfall
- If the proceeds of the windfall-in part or full-come very quickly into your bank saving account, you are sure to experience a surge in liquidity. There will be an urge to spend it as is the case with most windfalls.
- Higher liquidity is always propelled a person to take a higher level of risks than before. In the new situation, new possibilities open up for investing in assets with higher risk with a promise of higher returns in the long term.
- Most of us windfall money based on where it comes from; by doing so the value of that money appears to be less i.e. Treating windfall money as “Free-Money” or “Loose-money”.
Here is an action plan for managing windfall gain to drive a life-long advantage out of a windfall gain. The suggested manageable could be:
- Take a break: It would be prudent to take a break and create a cool-off period by putting all the money out of the harm’s way in a short term bank fixed deposit, may be for a month or longer. Short-term debt funds and money market funds with an established track record could be other avenue, especially for those in the highest tax brackets and where the amount of windfall is quite substantial. With the money being put away, you can now coolly work on what you need to do with your windfall. Don’t take any decision in a hurry.
- Pay-off Debts: A windfall is fantastic opportunities to get rid of any regular drain of income, such as the repayment obligations loans like those from credit cards and personal loans, which have exorbitantly high interest rates. Next is the turn of loans which have been used to acquire assets, with the costlier car loan coming first, followed by any educational loan and then, of course, home loan. What happens if you exhaust the windfall in this exercise? The answer is rather simple. By paying-off debt, you will be partially or fully debt free and will have more extra money left in your pocket resulting you continue the EMI, but in systematic investment plan(SIP) of equity funds that you were already invested in.
- Creating contingency funds, risk covers: Windfall gain needs to be utilized to create emergency funds, typically 3-6 months of expenses in case of loss of job, health problems, temporary disability or other unforeseen events. Same is true for life, health, home and disability insurance cover where a review will be required. More so for life covers, since your net worth would have itself gone up.
- Prioritize spending: Whether it is 10 percent of the net windfall or 50 percent, spending heads will need to prioritize. The focus needs to be on items that continue to provide benefits over time, such as home. Windfalls may spur you to increase monthly expenditure outlays, but this needs to be countered with a query as to whether this increase is sustainable.
- Make provisions for tax savings: If the windfall is originating from the sale of property or other sources whether it is possible to save taxes, such as those in capital gains, you will need to figure out whether some of the money would need to go into tax saving devices, such as those providing Section 54 EC benefits. Since, taxes are taken into account at the outset; this exercise would hardly be stressful and cumbersome.
- Career review: Since a windfall increases the capacity of an individual to take risks, it could be used to cushion the impact of a career transition that you could always be seeking, but not being able to take the plunge due to financial considerations. In times such as these, you need to your career review and make transition.
Cautions in Windfall gains
- Beware of friends for profit: An unexpected windfall will surely bring in lot of friends who may not really be interested in your charming personality. Make sure that you don’t end up being their bills paying ATM.
- Beware of Insurance Agents: While getting a bonus may not attract a big number of insurance agents, winning a lottery or inheriting large property certainly will bring crowd of insurance agents to your door step. Treat each one of them with suspicion and let them prove their worth to you before you become a victim of their scheme to turn your money into their income. You will find all kind of advises from investing in multiple avenues to selling off your property. Don’t take any such deals at face value. Make sure you evaluate the pros and cons and only if you are satisfied and assured then go ahead with the deal. If you are not sure or not clear about even one thing then it is best to walk away from the deal.
It is clear that managing a windfall is all about making every penny count for a lifetime. Before doing anything rash with a large sum of money, review your financial picture. Identify your goals, evaluate your risk tolerance and create a long-term plan for your money. Consider enlisting professional help. Financial planner can help you make choices that are right for you. There is no better tool than a comprehensive Financial Planning to ensure the same.
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