This begs a question: What should you do if such a windfall falls into your lap, whether a jackpot, a large inheritance or huge profit from selling a business?
I have pondered this for years as an economist researching personal finance issues. I also ask my undergraduates every semester what they would do if they suddenly got $1 billion. The standard student response is to pay off their sizeable college debts and travel the world.
Here are a few tips based on research for how to handle an unexpected windfall.
The urge to spend is a huge problem.
As I noted in a recent article, people who come into large sums of money end up bankrupt. My own research found that the average person in their 20s, 30s and 40s who was given an inheritance or large financial gift spent or lost half the money relatively quickly. A 2011 paper found that people who won mid-sized prizes in the Florida lottery were more likely to file for bankruptcy than small lottery winners.
The data suggest it takes time and experience to radically adjust to a different lifestyle. Given these problems of self-control, my advice is simple. If you win the lottery, do not take the lump sum payment. In the case of the Mega Millions jackpot, that allowed a winner to receive $878 million immediately – before taxes.
Instead, take the option to receive annual payments over 30 years, which is still an incredible amount of money each year. And if you happen to have issues with self-control and spend the entirety of your first and perhaps second payment on fancy homes and cars, you still have 28 or 29 years of additional payments – which get larger over time – to get your financial house in order.
If your windfall came by another means, such as inheritance, it’s still easy to handle a self-control problem. Many insurance companies and brokerage houses sell annuities, which operate just like that 30-year lottery payment option.
An immediate annuity is a simple contract. You give a certain amount of money to an insurance company and in return it gives you a periodic payment, which factors in inflation, for either a fixed term or for your entire life.
You can buy happiness
And so what’s the best way to spend that money?
He found that the best way is not to spend money on yourself. Instead, spend it on other people by giving money to charity and provide small sums for helping others.
Norton suggests small gestures like buying other people coffee will make you happier. If you have a large windfall, walk into a coffee shop and pay for everyone who is in line. If you are out having a beer, treat the entire bar to a round.
His research suggests this will make you happier.
Dealing with loved ones
But a trickier issue is how to deal with relatives and friends. Once you hit the jackpot, many people will likely come calling, even those you have not seen in years. Suddenly, you’re the dearest person they know.
My suggestion is to make your friends, family and other loved ones as happy as possible. And to do that, you could give them a share of your winnings – but research on money and happiness suggests not too much.
Psychologists Andrew Jebb, Louis Tay, Ed Diener and Shigehiro Oishi studied thousands of people around the world and found that having an income in North America of about $105,000 per year maximized happiness. Getting more didn’t make people happier.
Based on this research, if you are going to dole out cash to your friends and family, keep it to about $100,000 per year for each person. If you want to help people in your life for a long time, then buy them an annuity that pays $100,000 a year for the rest of their lives.
Giving them more may do more harm than good.