Editor’s note: This article was first published in April 2015; its reference to today’s low interest rates and the 8% and 5-6% return thresholds reflect conditions in 2015.
Everyone believes they could handle a sudden windfall, whether from winning the lottery or inheriting a large sum of money. But the statistics say otherwise: very few people know how to manage that kind of money. We have already looked at what to do if you win a big lottery prize, steps that not everyone takes into account.
Now let’s look at the most common mistakes people make when they receive an inheritance in cash.
1. Paying off your mortgage straight away
This is probably the biggest temptation for someone who receives enough money to get rid of their mortgage. Doing so will make you feel completely free of burdens. But it is probably not the smartest financial decision in every case, and you need to run the numbers with an adviser (if you don’t feel able to do it yourself).
We have to do the maths, taking into account today’s low interest rates and the tax advantages that come with paying a mortgage. If you get rid of your mortgage payments, those tax advantages will also disappear, which, as a general rule, could cost us quite a bit more than the mortgage interest.
What we should get rid of as soon as possible is toxic debt, such as credit cards and any debt that carries high interest and no tax advantages.
2. Trying to make more money quickly
After a windfall, we believe luck has finally come into our lives, so we have to make the most of it right away and squeeze out the highest return so the streak continues.
That is when we fall victim to “high returns with no risk”. Some savings and investment products will offer you an 8–10 percent return with no risk. It’s a lie. If you don’t have financial knowledge, those products are not suitable for you. In fact, they are probably not suitable for anyone, because nobody today can guarantee you 8% with no risk.
As a general rule, when we see the word “guaranteed” on investment products that promise more than 5–6 percent, we are almost certainly dealing with something very risky, illegal or possibly a scam.
3. Guru syndrome
Also known as “turning into a pompous jerk”, it is very common for someone with no financial knowledge who receives a large amount of money to start believing they are Warren Buffett.
At that moment, you should look in the mirror and remember that you are the same fool as before, only with money you were given, and not forget the well-known saying that the fictional character Gordon Gekko played on: “A fool and his money are soon parted.”
In short, your cash may have grown, but your financial knowledge is exactly the same, and that is an explosive mix for doing something crazy if you decide to dive headfirst into equities or unfamiliar businesses you don’t really understand.
4. Going for luxuries
That high-end car you have dreamed of so many times might seem like a good idea at the time. It isn’t. You should start thinking about how the money can grow, not about what you can spend it on.
A car is one of the worst investments you can make, so the more money you spend on one, the more money you are throwing away, and the more you are failing to earn, or even losing, in the long run.
Remember that with certain expenses it is not only the purchase but also the upkeep. I know of people who decided to buy a flat in a luxury building because they thought they could afford it, but 1,500 euros a month in community fees (the shared charges for running the building) was too much for people who tried to live like the rich, when in reality they had only received an inheritance that let them look the part (at least for a while).
5. Telling the whole world about your new situation
Just as there are “reckless” people who love to get in front of the cameras when they win the Christmas lottery (Spain’s huge annual draw), in these cases it is very common for the person, overcome with joy, to start telling people about the money they have received.
You will then see people start to come closer to you, and your circle of friends will grow… but in reality they will be more interested in what they can get from you.
In the same way, you paint a target on your back for criminals. So avoid drawing attention and keep your new situation as secret as you can.
There must be many more mistakes we could make, but these would basically be the most notable ones. Sometimes the best thing is to do nothing for a while and not make any decisions until some time has passed and we have been properly advised.
Further reading
- This is the best question to measure the health of your personal finances
- 6 things the middle class doesn’t quite understand about the rich
- The best books on financial education
Featured image: David Wilkie, Public domain, via Wikimedia Commons.
