On July 20, 2009, investors in pharmaceutical company Humane Genome Science (HGSI) woke up to a shock when the price of their shares opened about 400% higher than the previous close. The boost came from the unlikely success for of the experimental drug Benlysta, which met its goals in a late-stage study in treating Lupus.
The sudden and unexpected breakout of HGSI generated a lot of unanticipated wealth for its shareholders. I heard one story of a guy making $2.5 million that day and another hitting the $1.8 million mark. Handfuls of individuals proclaimed to have made thousands of dollars from the surge. Even, I got a piece of the action.
Back in February I purchased 100 shares of HGSI for $2.34/share. On July 21, 2009, I sold those same shares for $14.23 each, netting $1,164.00 in profits after brokerage fees. Although the $1,164.00 was not a “life-changing” amount, in my situation, it was definitely a windfall. Thus, I was inspired to write about how to deal with a windfall.
Below are some of my thoughts on windfalls and how they should be dealt with. Given that I am a firm believer in building wealth slowly through saving, it may come as no surprise that I don’t advocate going a shopping spree. However, I do believe in living a little every now and then, so don’t go putting all your winnings in the sock drawer just yet!
Windfall sources
You don’t have to take the risk of buying and selling stocks to receive a windfall. Accumulated wealth is all around you. You just have to be lucky enough (or smart enough) to be its recipient. Just look at these examples:
- Inheritance
- Sale of a home, property, or business
- Settlement of a lawsuit
- Collection of a life insurance policy (heaven forbid!)
- Work bonus
- Winning the lotto!
What constitutes a windfall?
The question above is a bit of a personal one. One man’s windfall may be another man’s pocket change. I’m sure many consider my earnings to be meager, but to me, they were very substantial.
I personally place windfalls fall into four different categories: small, medium, large and retirement!
- Small – $100-$1,000
- Medium – $1,000-$10,000
- Large – $10,000-$100,000
- Retirement – >$100,0000
Although I admit they may appear a bit arbitrary, there is a little reasoning behind the values I used. A windfall under $1,000 is nice, but somewhat commonplace. Between $1,000-$10,000, there is a bit of excitement, as the cash influx starts to open up opportunities. Receiving over $10,000 at once, will definitely change your fortunes, allowing you to pay off debt or make a down payment on a house. Greater than $100,000, you have a life-changing event. You may not be able to retire as my label implies, but you can definitely think about major career and/or lifestyle changes at that point.
Why you should have a windfall plan
Biggie Smalls once said, “mo’ money, mo’ problems.” Now, I don’t think this is entirely true. In fact, unlike popular belief, it is my opinion that money actually solves a lot of problems. However, Biggie has point.
Even the smallest of windfalls can be emotional events. Being unprepared for one leads many to seek immediate professional help. Well at least the smart people do, as the media is full of tales about individuals acquiring a large chunk of change only to be unprepared and uneducated about financial matters. Purchasing cars and homes, most of them are back to where they were in only a couple of years - their money spent (unwisely) on depreciating assets.
Thus, its crucial to plan ahead now before your ship finally comes sailing in. Consider the following suggestions:
- Pay taxes: I will have to pay capital gains taxes on my $1,164.00. It won’t be too bad given the small amount I made; however, if you receive over $100,000, the IRS is going to be looking for their cut. Thus, pay the taxes first to avoid major headaches down the road.
- Pay down debt: If you have debt, it makes the most financial sense to pay it off after you have paid taxes. Think of it might as a once in a lifetime opportunity to get yourself out of the hole
- Treat yourself: You gotta have a little fun in life. Given the joy and stress new-found wealth will likely give you, I would suggest using a small percentage of it to relax. However, I would stick to <3% and not to exceed a few thousand total.
- Take a cooling off period: After getting over the initial shock, the next thought to go through our minds would likely be what we would spend it all on! However, resist the temptation and revel in the moment, rather than new toys.
- Get professional help: One thing every fat wallet needs is a good accountant. Do not visit a broker!
Final thoughts
In the end, I left my $1,164.00 in my brokerage account. I figure another opportunity to reinvest it is always around the corner. However, if it would have a life-changing amount, things would have been different.
My plan for any windfall over $100,000 starts with paying taxes. After taxes I plan on treating myself first and then immediately putting 85% into long-term savings. The remaining 12-13% will go into a liquid account waiting for me to “cool off.” After I have settled down, who knows? All I really know for sure is that I won’t go and blow it!
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