Windfalls: Wonderful or woeful?
The answer has a lot to do with how effective a financial advisor is in counseling a client who has suddenly come into a large sum of money.
Too often, the end result of a windfall is ruin, notes Geoffrey Schaefer, CFP, a wealth advisor with Intergy Private Wealth in Colorado Springs, Colo. One third of lottery winners go bankrupt within five years, and 78% of NFL players face financial hardship, with nearly 16% going bankrupt after leaving the league, Schaefer says.
He and other advisors provided written comments as part of a survey by Dynasty Financial Partners on how advisors should deal with windfalls.
Riding the Emotional Rollercoaster
One of the biggest challenges for advisors is client psychology. Windfalls generally come in two flavors: expected and unexpected. Both can be emotionally challenging for recipients, but it’s the second kind that causes the most problems.
“We’ve observed the most acute emotional reactions when the liquidity event is the result of a quick, unexpected event,” says Derek Wittjohann, CPWA, CFP, chief operating officer and partner with Premier Path Wealth Partners in Madison, N.J. “We’ve seen clients experience a full spectrum of emotions: shock, guilt, elation, sadness, anger, fear, relief, uncertainty,” he says, noting that unanticipated windfalls include inheritance, legal settlements and insurance proceeds.
On the other hand, business owners who sell their business often have years to prepare for their windfall, allowing for detailed planning and easing the emotional rollercoaster of sudden wealth, Wittjohann and other advisors say.
Andy Arnold, CEPA, AIF, CEO and senior wealth advisor with Centerline Wealth Advisors in Louisville, Ky., says emotions can get in the way of effective windfall management. “Some attach an inheritance to the emotional pain and feeling of loss of a loved one and may be reluctant to consider spending even a penny (especially if the inheritance comes from an elder who focused on saving and accumulation),” Arnold says. “Clients will often compartmentalize certain windfalls, i.e. this was money mom saved, so I’m not going to touch it either,” he says.
On the other hand, an unexpected windfall can lead to unrestrained spending on the part of the client.
“In general, money received from a windfall, especially inheritances, gambling winnings, or settlements, is spent more easily than money that is earned, saved and invested,” Schaefer says.
Take it Slow in the Beginning
To safeguard against these dangers, several advisors say the first step for clients who come into a windfall is to take it slow.
“Don’t change anything right away,” Schaefer says. “Many windfalls involve life-changing money, but a dramatic lifestyle change or large expenditures may jeopardize the sustainability of those funds in a long term plan.”
“Our first piece of advice to a client following a windfall is to do nothing,” say Peter Lee, founding partner, and Jon Nickow, principal, with Summit Trail Advisors in Chicago.
“Take a year to settle into this newly created wealth/liquidity and think about your long-term goals and aspirations for this wealth,” says Lee. He reports that windfalls are the “most significant” part of his practice, with over 50% of clients being first-generation entrepreneurs who have experienced a windfall or liquidity event.
Jerry R. Sneed, CFA, CAIA, senior vice president of Procyon Partners in New York City, suggests getting away from it all. “Initially, I would recommend taking a pause and allowing oneself some breathing room, perhaps even considering a brief getaway.”
Client Education is Key
A client who comes into unexpected wealth has a lot to learn about handling their newfound riches responsibly and sustainably, a goal some advisors actively pursue.
“Transitioning to the role of an investor can feel like taking on a new full-time job,” Sneed says. “Our approach to planning for clients with windfalls places a strong emphasis on education, delivered through intensive sessions over a series of meetings within a short timeframe,” says Sneed, whose firm gets three to five clients/introductions per year with substantial windfalls, usually through a mergers and acquisitions.
Wittjohann’s firm also actively educates clients and takes a go-slow investment approach in the beginning. “Education is incredibly important during this time. Despite their varying levels of experience of financial markets, when the stakes are much higher, it’s important to carefully guide them through multiple investment cycles, how we handle and prepare for pullbacks in the market, what our investment philosophy is.”
Wittjohann says his firm starts with dollar cost averaging, the stock investment approach that puts a sum into stocks in monthly increments, for six to 12 months. “Clients may intellectually understand the planning and education we’ve provided, but if they see their newly acquired wealth drop 10% over a short period of time, lacking the historical context of having been through these market cycles before, it could skew their long-term perspective and derail what would otherwise have been a successful financial strategy,” he says.
He also acknowledges that maximizing returns is not the goal. “Although the math would tell you that dollar cost averaging generally does not yield better financial results, it does help the client acclimate to the new wealth and new investment strategy.”
During that period, client and advisor can develop a long-term strategy, says Wittjohann.
Lee and Nickow say the first step may be to “park” the windfall. “In today’s interest rate environment, investments as simple as floating-rate Treasuries offer a very attractive yield and can be a nice ‘parking spot’ for this windfall while families are creating their longer-term vision and plan.”
Planning for Philanthropy and a Legacy
A long-term vision could involve a commitment to philanthropy or creating generational wealth, several advisors say.
“Spend as little as possible until you realign the values you have set within your plan,” Schaefer advises. “If charitable giving and leaving a legacy were important before, a windfall shouldn’t change that. Be sure to stay grounded in what truly matters to you as the size of your portfolio doesn’t change your values; it simply changes how you can address them.”
Lee and Nickow concur. “Planning for clients at this level is much more about legacy planning across future generations and philanthropy vs. traditional planning around one’s spending,” they say. “Our investment platform is highly focused on private investments, which are typically an important piece of a portfolio for any family that has created truly generational wealth.”
Some Clients Don’t Listen
Advisors admit they can’t always keep clients on a sustainable course.
“We do everything possible to help a client see the folly of excessive withdrawal rates,” Arnold says.
That doesn’t always work, says Matthew D. Liebman, CFA, founding partner and CEO with Amplius Wealth in Blue Bell, Pa. “Despite our best efforts, some clients refuse to listen and exhibit self-destructive behavior after a windfall. The most common mistakes are overspending and/or speculative investing,” he says. “We do our very best to connect with clients and explain the pitfalls of their recklessness. You need clients to buy in, though, to avoid bad outcomes.” His firm gets new clients with windfalls about once a month.
Arnold says his firm sometimes has trouble advising a deceased client’s adult child who has inherited a fortune but can’t stick to the prescribed financial plan. “This new client squanders the windfall. Oftentimes we will hear repeated excuses as to why they need yet another withdrawal. For example, ‘I owe the IRS back taxes,’ or ‘My car died, and I need a new one,’ or ‘I’m behind on bills and so I need to catch up just this once,’” he says. “If they view it as a means to acquire a lot of expensive things quickly, there is almost nothing we can do to manage expectations.”
Changing Lives for Good
But of course, a properly managed windfall can help a client fulfill their dreams.
“In one instance, I was speaking to younger clients who had recently received a very large gift from an aging relative,” Schaefer recalls. “We had been in the process of planning for them to drop to a single income so one spouse could stay home with their young family.”
But the couple were in an area where the cost of living was high, making it difficult to reach their goal — until the windfall.
“They were ecstatic,” Schaefer says. “Relief, excitement, and gratitude all at once. They simply needed to see how the windfall supported their vision for their young family.”
In a four-decade career in journalism, Ed Prince has served as an editor with many of New Jersey’s leading newspapers, including the Star-Ledger, Asbury Park Press and Home News Tribune.
