Thirteen lucky people from Edmonton became Canada's latest multimillionaires last week, winning a near-record $49.9-million lottery jackpot. That sounds like a lot of money, but financial planners warn that the windfall could disappear quickly without proper planning.
The winners, colleagues at a financial services company, were chauffeured to a downtown hotel in stretch limousines where they mused about what they will do with their newfound wealth. While one woman debated the merits of buying an island, most others said they planned to spend their share of the winnings - nearly $3.9-million - paying off debts, mortgages and helping loved ones.
Tony Maiorino, vice-president of high net worth strategy, wealth management, at the Royal Bank of Canada, says people who suddenly get a substantial amount of money - through winning the lottery, getting an inheritance or insurance settlement, or selling a business - should avoid making any immediate financial decisions.
"The first thing you want to do is take stock and let your emotions come down," he said. "Three-point-nine-million is a life-changing amount of money but it can also be depleted quickly if you are not taking stock of what things you want to do and prioritizing them."
Although helping a son or daughter pay off their mortgage will likely bring the winners much pleasure, they need to sit back and get a clear picture of what spending that money now will mean over a longer period of time, he said.
In the case of the Edmonton financial workers, investing all of their winnings into a balanced portfolio of equities and bonds would generate an income of up to 6.5 per cent a year, based on a historical average. According to Mr. Maiorino's calculations, a more conservative estimate of a yield of 4 per cent would generate income of around $156,000 a year, before taxes.
"Depending on what your lifestyle is, that could be enough to live off of," he said. "That also assumes you don't pay off any debt, or help family with their mortgages or go out and buy a bigger house or cottage. If you burn through $1-million right away, then you are starting with $2.9-million and then you have $40,000 less income a year. The difference is astounding."
How much a winner should invest also depends on their situation, he said. If the winning couple has no debt, his advice would be to pay off any liabilities, and invest the rest into a combination of accessible cash, longer-term bonds and riskier equities.
Sloan Levett, director of wealth management for Fuller Landau LLP, says the temptation for people who come into a windfall is to spend heavily in the beginning - to pull the trigger on a bigger house, a cottage or a sports car. "They think they can't possibly spend all this money and they start cutting cheques all over the place. But they can. I have seen it happen."
In addition to shelling out the capital, winners who dramatically increase their spending habits can find that eventually, they will no longer be able to afford their new lavish lifestyle. "To sustain a bigger lifestyle costs more money, so you get into a spiral of needing more money to maintain it," said Mr. Levett, who consults with high-income earners. "Now instead of needing $40,000 a year to live on, they find they need $120,000."
Both men say how much of the money that should be invested - and in what - depends on the winners' specific goals and situation: their age, how many kids they have and whether they have any major liabilities. If the long term plan is to not work and they have no major debts, they should decide how much capital they want to keep for themselves and decide on a budget for their lifestyle. Counting on a return of 4 per cent, they should then figure out how much capital they need to invest in order to generate that lifestyle.
Here are Mr. Maiorino's ten tips for Canadians who have hit a financial jackpot:
Do not make any financial decisions immediately You are at a very emotional time where your thought process around the benefits of the money, on a long-term basis, could be severely impacted. For the first 90 days, avoid making any decisions on what to do with the winnings. While you are deciding, you could invest the money in a short-term, secure, liquid instrument, such as a treasury bill or money market fund.
Assemble a financial snapshot Whenever you have a material change, like a financial windfall, you need to understand your expenses and liabilities. Take a hour to make an inventory of what you owe and what you spend money on.
Set aside a small amount as "fun money"
Once the 90 days is gone, set aside some money, say 10 per cent or 5 per cent, that you will not use to invest or pay off debt. This is the sum you can use to enjoy with family, to satisfy a wish list. Planning like this leads to good decision making.
Make a wish list and write it down
Make a plan of what you want to accomplish. For example, do you want to buy a cottage, send your kids to private school or start your own business? Compare these goals with the immediate joy of a vacation or a new car. Again, planning results in good decisions.
Prioritize your wish list Have the difficult conversation of what comes first - private school for the kids or summers at a family cottage? Even though it is difficult, place them in order of importance and make decisions from there.
Learn to say "No" … or at least "Not yet" to requests and solicitations Don't feel bad turning down or delaying requests from family, friends or various charities. Decide what is important to you and what you want to fund.
Develop a personalized long-term financial plan with the help of a professional investment adviser Now that you have established goals, look at how you can get this money to do what you want it to, especially down the road. Sit down with financial planner and decide how to obtain your desired financial objectives.
Review your will A life-changing event like a large sum of money will render your old will (if you had one) irrelevant almost immediately. People need to review the clauses in their will, make sure they have living trusts, and consider things like income splitting with minors to ensure favourable tax treatment.
Careful tax planning can save you a lot of money Work with an adviser to build a portfolio that meets your risk parameters but takes into consideration a tax minimization strategy. Understand the difference between how interest and capital gains are taxed in Canada. In addition to your portfolio, understand how structures such as insurance, as well as the use of trust and charitable giving, can benefit you from a tax perspective.
Invest to provide regular cash flow for the rest of your life If you want winnings of $3.9-million to fund your lifestyle, you need to understand how much can be generated each year and the long-term effects of inflation. Your age, your desired lifestyle, your debt level and what kinds of savings you have will help determine what kind of portfolio you can set up and how much it can yield for you.