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What would you do if you won Lotto? Last week three people did win, picking up $13.3m each. It would be interesting to know how they handle that and what they do with the money.
The trouble with windfall gains like Lotto is that what can seem a large amount of money can quickly become a fairly small amount of money. Even when the money remains the same (i.e. it is not lost or spent) a psychological phenomenon called hedonic adaptation kicks in. This means the new things that we are able to buy, quickly become old hat and cease to give us happiness.
Studies show that lottery winners get over their initial euphoria and within eighteen months are no happier than nonwinners. Unless Lotto winners keep buying more and better things, happiness will drop to previous levels; and buying more and better things is not endlessly sustainable.
I certainly know people who have not been able to hold on to the large lump sums that they have received. This is from poor investment decisions, over spending on lifestyle assets and, sometimes, because long lost friends and family reappear. There are plenty of people who have lost what they have received pretty quickly.
This is not just Lotto winners. A lot of people ‘‘win lotto’’ even though they do not have big gambling wins. Many people receive large lump sums when they sell a farm or other business, cash in superannuation funds or receive inheritances. These are not really windfalls and often not unexpected but they are difficult to manage. I have said before on these pages that the hardest thing in finance is to use a lump sum to generate a steady income on which to live.
My first advice to such people is they should put the lump sum in the bank for a few months to get used to the idea of having it. This allows you to make a plan for how it will be spent and invested. In my view, the first thing to do with a lump sum is easy - do nothing.
When you come to planning, there is a fundamental divide between lifestyle assets and income-earning ones. Getting the right amount to each is the critical part of planning. Lotto winners often talk about the lifestyle things they will buy, such as a new house, new car or an overseas trip. They focus on these kinds of purchases and little thought seems to be directed towards capital for income.
I would turn this on its head: Lotto winners (and those with lump sums readying themselves for retirement), ought to calculate the amount they will need for their ongoing income first. Only when they have set aside enough capital for their income should they consider the lifestyle assets they can afford.
Martin Hawes is an Authorised Financial Adviser. A disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.