If a brown paper bag appeared on your front door step today with $5000 cold, hard cash in it what would you do with the money? Would you buy a new “toy” with it like a motorcycle or a down payment on a boat? Would you pay off a loan with it? Would you invest the money? Spend it on a vacation? Although some of the astute readers of this blog would make the money work for them by paying off high-interest debt or investing it in a stock mutual fund many others would spend the money with little or no financially beneficial planning. Many businesses such as car dealers or tax preparers today will gladly help you spend that money foolishly as discussed here. Some of these tax refund loans can have interest rates of 200% to 2000% which should be illegal. Let’s discuss two ways people spend unexpected cash windfalls and why you should be a member of the latter group.
The Impulse Buyer
I had a friend once who received an inheritance of $13,000 from a deceased aunt and put that money into the world’s worst investment. My friend probably slept on this newfound money at most a day or two if that. At the time he had not completed his four-year degree and since this was the early 1990s that $13K could have helped him wrap up his diploma. If you analyze just those two purchases alone (a car or a four-year degree) one will be worth nothing in 7 – 8 years and the other can literally be worth over a million dollars over a lifetime. Yes, a college degree will always be worth far more than any car. My friend spent his unexpected cash windfall as an impulse buyer. He did not have to work for this money, did not spend years saving it up (but his aunt did) and most importantly did not fully appreciate how a mere $13K could have had a major positive impact on his life. Hopefully some day my friend will realize the true potential of what modest sums of money like that inheritance could have done for him by now fifteen years later.
The Thoughtful Investor
When this type of person receives an unexpected sum of cash she can finally implement her plan that she had been devising all along for this day. Start a small business with that cash, invest it in the market for the long haul, put a down payment on real estate with that money or use it to kick-start a plan of paying cash for everything. Whatever our fictitious receiver of this cash does with the money you can be assured that she won’t regret it one month, six months or one year later. Her brain and spending habits had already been programmed to spend wisely sums of money both great and small. In other words, this unexpected cash windfall merely helps her accelerate her financial plan at a greater pace.
Windfalls the De-motivator
What if your parents told you that you were going to get brand new car for your sixteenth birthday? What if your parents told you that you’d get $50,000 for a down payment on a house when you get married? What if they told you that you’d get $200,000 of their estate on your thirtieth birthday? What effect would that have on your subconscious mind? Suppose you were in your late 20s at a job you hated? How long would it take for your mind to say “what’s the point of trying to succeed at this dumb job if I’m getting $200,000 in two years when I turn 30?” As detailed in the Millionaire Next Door parents like this are unknowingly giving their children economic outpatient care. In other words, they are actually doing their children more harm than good. They are de-motivating their children to succeed financially in life. If you play chess with your kid for years and years and always let your kid win, how prepared will he be during his first real chess tournament? That tournament loss will hit him like a ton of bricks without Mom or Dad letting him win. The same is true in finances. If your child never learns to appreciate the value of money how will your child be expected to turn out when she has her first big financial fiasco like a runaway credit card bill or car repair. She’ll expect Mom or Dad to be the financial knight in shining armor. I believe children turn out best financially when they either a) have no idea of their parents true net worth or b) expect to get little or nothing when their parents die. Anything else will just act a demotivator for the child.