Dealing with financial windfalls

Becoming the lead advisor to a recipient of a financial windfall can be one of the most exciting and professionally satisfying engagements of your career. But the role often demands a broader approach and keener sensitivity than is required in most client relationships.

A financial windfall is any distribution of financial assets that leaves the recipient with dramatically greater liquid wealth than they had been accustomed to managing before the distribution. The windfall may be the result of a major inheritance, the sale of a business or property, or the proceeds of divorce or insurance settlements. It may come from a severance or retirement package, or from receiving the commuted value of a pension plan.

Windfalls can also come from sadder circumstances, such as when someone becomes a widow or widower. In this case, the responsibility to look after all the financial assets that were previously managed by the deceased can be daunting. A happier form of windfall is the sudden ascent to riches enjoyed by professional athletes, entertainers and artists. And the most publicized windfall of all — but hardly the most frequent — is the lottery winner.

Regardless of whether the windfall recipient is an existing client or a windfall walk-in, the majority of them need a financial advisor with good instincts, good ears, a solid network of compatible professionals, a well-defined approach to financial planning and investment management, and a lot of patience.

As much as their bags of money attract the attention of the financial community, windfall recipients are often carrying around more baggage than just financial assets. There are often important psychological and sociological dynamics taking place in their lives. If we can understand and help clients cope with these issues, we will be much more effective in providing financial advice and services.

Stephen Goldbart, a California-based psychologist, coined the term Sudden Wealth Syndrome (SWS) in the 1990s to describe the psychological challenges faced by the newly rich entrepreneurs of Silicon Valley as a result of their sudden success and wealth. He observed many of these individuals suffering from a variety of stress-related disorders, all linked to the responsibility of having to deal with the dramatic increases in their net worth. Dr. Goldbart determined that people with SWS exhibited symptoms such as paranoid thinking, fear of loss of control, excessive guilt and sleep problems.

Windfall recipients also face interpersonal pressures. Family members, work associates, friends (both of the current and long-lost varieties) may approach them for handouts, or become jealous. Long-standing family and social relationships may be tested as the windfall recipient moves a few rungs higher up the economic ladder.

How we help windfall recipients

With most of our clients (see sidebar, “Meet some windfall recipients”), especially Matilda, the best course of action was to proceed slowly and educate her every step of the way. Once trust was eventually established, Matilda was able to respond independently to our advice, and the relationship moved forward.

As enticing as it is for financial advisors to demonstrate investment acumen or planning smarts, the best piece of advice you can give to a new windfall recipient is to stop and do nothing. Clients should not make any consequential decisions until they have had time to absorb their new circumstances.

This advice applies to spending and giving money away as much as it does to investing the newly acquired assets. There is no reason to do anything quickly with the large sums of money, especially when the recipient is likely under duress, grieving or fending off those looking for a piece of the new pie. The best place for the money is in short-term savings vehicles, where it should be left until a proper plan is ready to direct how the money is to be allocated and deployed.

The windfall recipient usually asks us to assume the central planning advisor role for them. In becoming this advisor, we strive to educate, coordinate, evaluate and then allocate as we create and deploy a comprehensive financial plan for our client.

1. Educate

Our best clients are informed clients. As we endeavour to learn as much as we can about them, we strive to help them to understand the tools and methodologies we use during our engagement. At the same time, we probe extensively to ascertain:

• their knowledge base of financial and wealth management
• their real hopes and dreams for themselves and for those whom they care for the most
• their short-, medium-, and long-term goals and cash needs
• what kind of pressures they face from friends, family, health, business, etc.
• the names of the individuals and organizations they have been dealing with to date
• who else they turn to for reassurance when making decisions
• what kind of legacy they would like to leave in this world

2. Coordinate

Most windfall recipients need better advice — and more of it — than before. As noted above, a financial advisor with a solid network of compatible professionals can count on this network’s assistance in building and executing the financial plan. Internally, we engage the following colleagues as required:

• Private banker
• Estate planning/insurance specialist
• High-net-worth financial planning specialist
• Trust department professional

Externally, we engage the following professionals as required:

• Accountants
• Lawyers for general, family and/or tax and estate matters
• General insurance
• Psychologist or social worker
• Real estate broker
• Eldercare specialist
• Philanthropy consultant
• Under our leadership, these professionals meld into a dedicated, coordinated resource for the windfall recipient.

3. Evaluate

Using the financial input derived from our research and coupled with the recommendations of our expert colleagues, we are in a position to complete our financial projections and forecasts, and evaluate whether the output generated can indeed meet the goals and needs of our windfall recipient.

Our report contains specific suggestions on how the client should use his or her financial assets, and a list of recommended professional services. We endeavour to create a financial approach that maximizes the potential return in each risk category while minimizing the debilitating impact of income taxes wherever possible.

4. Allocate

Finally, we deploy the recommendations in the Evaluate stage. A lot of hand-holding takes place during the deployment, and we insist on getting regular feedback from our clients. We continue to educate them, coordinate matters with the compatible professionals, and review our work to ensure that our client is on track to achieve all their goals and see their hopes and dreams come to reality.

Meet Some Windfall Recipients

We have advised on numerous windfall engagements over the last two decades. These diverse cases (where the names and situations have been altered enough to maintain privacy) demonstrate the range of sensitive financial and non-financial issues we have navigated.

Cordelia

Cordelia became entitled to a multimillion-dollar divorce settlement from her ex-husband, Magnus. Throughout their married life, Magnus was the sole (and significant) breadwinner, and looked after all the finances. Despite having virtually no experience in handling significant sums of money, Cordelia suddenly became responsible for ensuring not only that her portfolio could look after her day-to-day needs, but also that it would provide for the rest of her life. She had complicated estate-planning issues to deal with, and didn’t feel her children, close relatives or friends could help her. Emerging from the protracted divorce proceedings was enough stress for Cordelia; the financial challenges only amplified the stress she was feeling.

Manny

Manny, a married, only child in his 50s with a modest investment portfolio and average earnings, inherited a low seven-figure investment portfolio from his late parents. Manny’s approach to investing prior to the windfall could best be described as conservative, but his approach to the inherited portfolio was one of veneration: he was afraid to risk one penny of the capital that his parents had accumulated lest that hard-earned money be lost.

Manny’s stress in dealing with his windfall was compounded by his grief over the loss of his parents and the guilt he was afraid of feeling should he lose any of the money left to him. Overcoming that emotional roadblock would be the key to proper financial planning and investment management of Manny’s assets.

Alvin

Alvin sold his business for proceeds far in excess of the investment assets he had in his portfolio. While still young enough to continue working — which he did for the company that acquired his business — he recognized the sale of his business was likely going to be the only financial windfall he would ever receive, and he wanted to ensure the capital would serve his needs for the rest of his life. He wanted his capital to grow to the point where he felt he could retire without compromising his lifestyle.

Evanka

Evanka had just spent several years of her post-adolescent life recovering from a series of life-threatening accidents. She underwent extensive hospitalization and rehabilitation, causing her to forgo years of university education and professional training, as well as earning power. Upon returning to her studies, she received a large cheque from the insurance company. While her future looked bright, the money had to cover a myriad of professional study programs, moving and living costs, ongoing rehabilitation costs and a buffer, should the longer-term effects of her accidents stymie her complete recovery.

She wanted the proceeds from the settlement properly allocated to both her known and unknown future costs, and invested to ensure she would have enough capital to meet these costs and achieve her professional and personal goals.

Matilda

Matilda was left a young (50ish) widow, with little personal financial management experience, a modest amount of assets and insurance proceeds, and an enormous amount of grief. She counted on the feedback of younger family members for her financial and other decisions, but they had less experience than Matilda. While open to developing new professional relationships, she was quite leery of the service providers she was meeting, including us.

The big reveal: how the windfall recipients fared

Cordelia survived the marital breakup well, and has been working with a top-notch group of professionals to help her plan and manage her complex situation. We designed tax-efficient income portfolios and cash flow statements for her, and Cordelia has now comfortably settled into her new circumstances.

Manny hasn’t quite broken away from the reverence he holds for the assets his late parents left to him, but he has started to gradually shift his overall asset mix to one that should help him more in the future. His wife joined in the discussions and this helped bring about some changes.

Alvin adopted a strict but comfortable asset allocation program, which he has adhered to religiously. He has had good results, especially given the megabumps that the world’s stock markets provided over the past decade. The cautious use of tax-effective structures has helped smooth out his after-tax returns. He is now fully retired and feeling confident about his financial future.

Evanka is well on her way, and we feel confident her financial situation has been structured to help her overcome the future challenges she may face from either a recurrence of the effect of her injuries or the time when she could not be a student. Finally, I am pleased to report that Matilda is living the high life — within her financial means — and has let our relationship become open and trusting.

Final thoughts

Most investment accounts grow organically from investment returns and regular additions to the portfolio. Unless dramatic changes have taken place in clients’ lives (or in market opportunities, tax laws and other external areas), most financial advice builds on advice given in the past. The advice that a windfall recipient needs includes all the suggestions that an advisor provides everyday clients, as well as specific advice that relates to the windfall and the recipient.

Most clients have built their wealth incrementally, and have grown accustomed to each step-up in their net worth gracefully, as they have more time to absorb the gradual increase in their financial assets. What distinguishes the windfall client from the ordinary client is the sudden increase in their asset base, and perhaps with that, their view of themselves and their world. As financial advisors, we can help them marshal these sudden changes to provide a comprehensive, systematic and sensitive way for them to deal with their new reality.

Stanley M. Tepner, MBA, CA, CFP, TEP, is First Vice President and Investment Advisor with The Tepner Team at CIBC Wood Gundy in Toronto. He can be reached by telephone at 416-229-5566 or 1-800-488-8688 or by e-mail at stan.tepner@cibc.ca. The views of Stanley Tepner do not necessarily reflect those of CIBC World Markets Inc. CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of CIBC, Member of the Canadian Investor Protection Fund and Member of the Investment Industry Regulatory Organization of Canada.