Written by Trent Hamm, The Simple Dollar is a popular personal finance blog that chronicles one man's road back from overwhelming debt to financial security. Hamm declared the contents of the blog to be in the Public Domain in 2008 and available for sharing when attributed properly. We will share a couple of posts a week.
Yesterday, we talked about the challenges of getting a raise. It’s always a good thing to increase your income, but if you make poor financial decisions with that extra income, it will go to waste and you’ll find yourself right back in the same difficult financial boat you were in before the raise.
The same phenomenon is perhaps even more true when it comes to a big windfall. If you don’t use it wisely, you’ll quickly find yourself right back where you started.
We’ve all heard the stories of lottery winners who took a big windfall and then found themselves bankrupt in a few years. People ask themselves how such a thing could possibly happen, but it makes sense when you think about human nature.
Think about what you’ve done whenever you’ve received a windfall. The initial impulse is to celebrate and to use the money to indulge in something you wouldn’t otherwise afford.
You win $50 in a raffle and it’s tempting to go out for dinner. You get $1,000 as an inheritance and it seems like a great time to replace that old television. Inherit $10,000 and it’s suddenly time to build a swimming pool.
I’ve known people who have done all of those things.
The impulse to splurge exists no matter how big or how small the windfall is.
Let’s look at a different approach, though.
A person who finds $50 uses it to buy groceries instead of going out on the town. A few weeks later, they’re able to easily make that insurance payment they forgot about without going into debt for it and they’re able to continue their forward financial progress.
A person who finds $1,000 immediately pays off a credit card that was charging them 20% interest on the balance. Not having to make that payment every month makes it that much easier to make ends meet an not fall into further debt.
A person who finds $10,000 puts it in the bank and in a year or so buys a late model used car by writing a check instead of getting a loan. There’s no monthly payments for that car at all, enabling that person to keep accelerating through paying off their other debts and reaching financial independence.
A person who wins a $10 million lottery pays off every debt he or she owes and puts the rest into investments, choosing to live off of the investment returns while re-investing 20% of those returns automatically. Their annual income is somewhere in the range of $300,000 for the rest of their lives and they have a massive amount to leave to their heirs.
But what about rewarding yourself after a windfall? The best reward is less worry. If you reward yourself with some big spontaneous reward, you don’t do much at all to get rid of the financial concerns in your life. Use the windfall correctly and you chip away at or even eliminate the financial stresses that hold you back.