Sunday, October 3, 2010

Lump sum Payouts

Most of us can't handle large amounts of money, since we have been trained since nearly birth to receive money in small monthly or weekly allowances.

If you are lucky in life, you may receive a lump sum payout at one time or another - perhaps multiple times.  It does not happen often to working class schmucks like you and me.  And as a result, we often "blow it" and end up broke later on.

Lump sum payouts may occur to the average working Joe when:
1.  They inherit from their parent's estate. 
2.  They take a buyout from their employer. 
3.  They sell a piece of Real Estate. 
4.  They settle a lawsuit or personal injury case. 
5.  They win the lottery.
In almost all of these scenarios, the average working Joe ends up squandering all of his money in short order.  When you are trained to survive on bi-weekly paychecks, any sum over $10,000 seems like a "lot of money" to most folks, and they simply cannot handle it.

It reminds me of something I once read about birds.  Supposedly, they cannot count above 4 or 5, so if you take one egg out of the nest - or add one - they don't notice it, so long as the number is above 4 or 5.   So you can steal eggs from a birds nest - and they will never know it - so long as you leave them with 4 or 5 eggs. 

In the same way, the average working schmuck knows $1000 is a lot of money, $10,000 is a whole lot, and anything above that is "doggone rich!"

And many people out there are aware of this condition and exploit it to the fullest extent possible.  Kurt Vonnegut, in Slaughterhouse Five, I believe, once told the tale of a lawyer who said to his son, something along the lines of, "There is a magic moment, when a large sum of money changes hands, where it does not belong to the person giving the money and it does not belong to the person receiving the money.  A good lawyer can take advantage of this moment, take the lion's share of that money and hand a pittance to the recipient, and receive his blubbering thanks".

Vonnegut realized that most wage slaves just can't handle large amounts of money - which they view as a mystery.  When given large amounts, it usually burdens them - and a whole army of operators out there will relieve them of that burden in short order.

I have mentioned this before in this blog - about fellow Attorneys who have no qualms about "harvesting" money from people too stupid to hang onto it.  In their view, any idiot with a pile of dough clearly doesn't deserve to have it!  So it is the lawyer's job to relieve them of that burden, and transfer that money to someone who knows how to use it - namely the lawyer.  It is an odious practice, but may lawyers have no qualms about it.

And this scenario plays out again and again.  Lottery winners go bankrupt in short order, thinking that a million dollars is a "lot of money" and spend it like they have 10 million.  Or people who squander large inheritances in short order.  And our literature is full of such examples, of young heirs who have no appreciation for money and run through wealth that took a lifetime to accumulate, in a matter of a few short years.

I had a client do this.  He sold his Patents for a few million dollars - more than most of us can spend in a lifetime.  I called him on the phone and he said he was living the high life - paid off his mortgage, bought a new luxury SUV - things were good.  I asked him, "Have you paid your lawyer yet?" and he said "Oh, been meaning to get to that!"    And he eventually did.

Five years later, he called me with a new idea he wanted to Patent.  Knowing he had all that money (and was a slow payer in the past) I asked for a retainer.  "Well, there's a problem there," he said.  Turns out he tried to "double down" his bet by investing his millions all in risky "dot com" stocks - and lost it ALL.  He wanted to be a "player" and he thought this money would be his ticket to the big-time - not realizing that it was already the big-time.

Oh well, at least he paid off his mortgage.

Another friend took an "early out" from work and they paid him in a lump sum, which he "invested" in a number of hair-brained schemes with fellow "investors" who robbed him blind.  In short order, he ended up with nothing.

Or another friend, who inherited a large sum of money, but never graduated from high school.  He decided to "prove himself" by starting a number of ill-fated businesses, all with partners who - you guessed it - looted the businesses and left him high and dry.  He finally realized that being "retired" was a lot cheaper than trying to be "in business".

I worked for a chef once, who receive a life-insurance payout when his Father died.  He was 28 years old, and had he invested that, would have been a multi-millionaire by the time he retired.  He decided instead to start a restaurant with his shady Uncle.  The Uncle had run a string of restaurants, many of which mysteriously burned down or went bankrupt.  And not surprisingly, he was stealing from all of them.   He had no compunction about stealing from his nephew (who he felt didn't deserve the life insurance money from his brother) and within a year, the restaurant went under.  The chef, distraught, shot himself in the kitchen.  He should have shot his Uncle, instead!

Or my water-skiing friend.  His Dad died, leaving him at age 25 with $40,000 of life insurance money.  His brilliant idea?  Buy a Corvette and a Ski Boat!  It was fun for a while, but after 5 years, all he had was a used car and a faded boat with a blown motor.  That money, invested at age 25, could have been worth over a million dollars at retirement, if invested properly.  Instead, all he has to show for his inheritance are a junked car and a junked boat!

The list goes on and on.  Young rock musicians hit it big with a "one hit wonder" and spend it all like another hit song is around the bend.  Superstar athletes spend money faster than they make it - convinced they are invincible, but not counting on bad knees and age catching up with them - and it always does.  And then you have Ron White.  I'm taking up a collection for him NOW, as he clearly will "spend it all" long before his stardom burns out.

Lower- and middle-class people just can't handle large sums of money.  We are not trained how to do so.  In some cultures, respect for money is taught at birth.  In our popular culture, we are taught only to spend, spend, spend.

If you are a wage-earning schmuck like the rest of us, what should you do if you inherit $100,000 or get a lump-sum payout from your job?  Most middle- and lower-class people immediately head to the car dealer and buy a "brand new car" and then go have Chinese take-out, or so the stereotype says.

But you have to bear in mind that a lump sum of money does not make you "rich" and that having a pile of dough around is a responsibility, not a "treat."  And moreover, this is your ONE SHOT IN LIFE TO GET IT RIGHT.  There is usually no "do over" if you mess it up badly.

Here is my suggestions as to what to do if you end up with a pile of dough:

1.  PAY OFF DEBT:  Many investment counselors will advise against this, as they want you to invest the money in their mutual funds and earn a 5% commission off the top.  They will tell you that your mortgage debt is "tax deductible" and thus a good thing to have.  But if you have monthly mortgage payments to make, retiring may be difficult if you've tied up your money in a mutual fund. Paying off debt is the SAFEST INVESTMENT you can make, as you instantly get a rate of return equal to the interest rate paid.  Pay off your mortgage, and save 5% interest over 30 years.  That is a TON of dough, and more than any bank or money market will ever offer.  And once you own your home are are DEBT-FREE, no one can take it away from you.  People who listen to investment counselors and keep debt while "investing" the proceeds of a lump sum can lose it all and end up not only with nothing, but also a huge debt.

2.  INVEST THE BALANCE IN SAFE HARBORS:  This is your one shot in life, if you are a middle-class schmuck like me.  Don't blow it by trying to "double down" on risky stocks.  If there is any left over after paying off your debts, put it into SAFE investments first, even if they don't have huge rates of return.  If you are nearing retirement, you NEED that money, and the amount of compound interest you will earn in your remaining years is trivial.  Young people can afford risky investments - you can't.  They will reap the yield of compound interest over 30 years - you won't.  So, while an FDIC insured bank account is not "sexy", there are no broker fees involved and it is as risk-free as you can get.

3.  DIVERSIFY YOUR INVESTMENTS:  Don't put all your eggs in one basket.  Spread out your investments over a number of areas and types.  At least if one goes South, the others may hold up.  As my friend who put it all in "Dot Com" learned, if you have all your money in ONE THING and that ONE THING goes bad, you are dead broke.  And that sucks, not only because you are broke, but because you once had a pile of dough, which makes being broke doubly sour.

4.  DON'T START A BUSINESS:  It is tempting to want to start your own business and "be your own boss" - but don't do it!  Very few people have the temperament to be a businessman, and 9 out of 10 new businesses FAIL in the first year.  It is the riskiest possible thing you can invest in, and the odds are you will lose.  Also, if you are a wage-earning Joe, chances are you will get creamed in the business world.  We all develop soft-headed thinking when working as salary slaves, thinking that "If I was boss, I'd be a lot more decent and nicer to my employees!"  But the real deal is, once you are boss, you realize that your employees will walk all over you, unless you are a hard-ass.  That is why salary schmucks think bosses are all "assholes".

5.  BEWARE OF PARTNERS:  An Italian friend of mine started a business with a partner and ended up having to buy them out.  He told me, "In Italy, we have a saying:  The best partnerships are an odd number of people, less than three."  In other words, go it alone.  As some of the examples above illustrate, there are predators out there who prey upon people who came into money in a lump sum and relieve them of it in short order.  Like the serial bad tenant, who preys upon the amateur landlord, the serial "partner" finds people with no experience and lots of money who want to start business ventures, and then pitch their business expertise as the needed "key" to making the business work.  They usually steal from the business, driving it under, and take the poor schmuck who financed it for everything he was worth.  Just say NO to starting a business and/or taking on a partner.

6.  BEWARE OF INVESTMENT COUNSELORS:  I went to an "investment adviser" once, for an "evaluation" of my portfolio, which was diversified among a number of stocks, bonds, mutual funds, life insurance, bank accounts, and real estate - the way it is supposed to be.  Her stellar advice?  Cash it all in and give it to her to invest in mutual funds represented by her company.  She even suggested cashing in life-insurance policies that were self-funding.  Her logic?  "One-stop shopping!  Convenience!"  Her take?  5% of my entire portfolio.  50 grand for an afternoon's work.  Not bad work, if you can get it.  I'm not saying that all investment counselors are low-life scumbags who should be slowly roasted alive over a barbecue pit - only that I haven't met one yet who isn't.

7.  DON'T BUY A DAMN THING!  It is tempting when you get a big check to say, "Well, I should spend something on myself, as I deserve a treat!   Wrong answer!  Consumer spending is one sure way to squander a ton of money in a real hurry.  Buying a new car or a boat or whatever, just because you inherited, is really, really stupid.  You are not "rich" now that you have a little pile of money.  That money usually has to last you the rest of your life. Consumer goods depreciate rapidly, and in short order, you will have nothing to show for your money.  A car is ready for the junk heap in a decade.  But money in the bank grows and grows.  Don't change your spending habits just because you have a little money in your pocket!

8.  DON'T RUN UP NEW DEBT:  One thing I see many middle class Americans do is to run up credit card debts to the tune of $10,000 or more (often much, much more!) and then pay it all off when they sell a home or get a small inheritance.  They are "debt-free" at least in terms of credit card debt, but only for a short while.  Before long, restaurant food and "shopping" have run up their credit cards again, and they are back where they started.  If you have the opportunity to get out of debt, make sure you stay out of debt - forever!   This may mean cutting up your credit cards for good and using only debit cards or cash.  Whatever it takes.  But don't just end up heavily in debt again, because you will be depressed as all get out!

For most of us, checks with six or seven figures in them rarely cross our palms in our lifetime.  We should look at these events carefully and insure that we "do the right thing" and not let our bad consumerist spending habits get the best of us.  For most folks, paying off debt is the first and foremost thing they should do, before investing the rest.  Because even if you lose the rest, at least you are out of debt, hopefully once and for all.

The nightmare scenario I see happening over and over again, is that Joe Paycheck gets his ONE SHOT at a big check, and he blows it all on ill-advised schemes.  He ends up broke and still in debt, but now with no way to ever pay it off - ever!

Our 401(k) society is an interesting experiment in money management.  Most people - nearly all of them, including ME - were never trained properly in the management and use of money.  Our culture promotes consumerism and spending over savings and money management.  It will be interesting to see how we make out as our retirements approach.  Many saved very little for retirement and will be very scared once it occurs.  Others will be tempted to spend their retirement savings all at once, on ill-conceived schemes or on consumer spending (cashing in the 401(k) to buy a yacht).  At age 59-1/2, I suspect many will simply clean out their 401(k) accounts in short order and end up broke.

Frankly, while I was a big fan of the IRA/401(k) concept when it started, I think it may end up be a debacle as retirement for this first generation of recipients comes closer.  If you read the statistics online, very few saved anything - and many saved paltry amounts, usually less than $100,000.  How such sums will be enough to live for 15 to 20 years is anyone's guess.  Living on Social Security may become a norm, not an exception, for our generation.  Perhaps we will all have to move to Panama or Costa Rica.

If you get a lump sum, think carefully about it.   It is hard to avoid the temptation to squander it, that is sure!