People have been asking me lately what to do if you get an unexpected pile of cash. Legal settlements, inheritances, lottery winnings (ha!) or just finding a toonie on the sidewalk. Should you pay off debt? Put it on the house? Invest in cryptocurrencies?
For most, any large lump sum of money is probably the result of an inheritance so let’s tackle that first.
- Go slow. Don’t spend one dime until you fully understand the plan and where it will take you in the future. Don’t do something because I’m telling you to or because a financial advisor told you about it.
- Get a team of advisors with regards to taxes, investing, estate planning etc. Interview these people and don’t hesitate to fire them if you smell a rat.
- Ask yourself if what you are doing with the money would be agreeable to the person who left it to you. I’m sure great-aunt Helga would frown on putting a sweet sound system in your ’05 Civic.
- Run down the list of steps I’ve outlined previously:
- Change your mindset.
- Get on a written budget for each month.
- Save $1000 mini emergency fund.
- Pay off all debt except your home from smallest to largest regardless of interest rate.
- Save 3-6 months of expenses in a real emergency fund.
- Start putting 15% of your gross household income into retirement savings.
- Live on money not credit, pay off the house early, and then max out all investments.
Example #1
Joe and Jane together make $100,000 per year gross. They have some consumer debt and a mortgage. Between RRSPs and TFSAs they have about $50,000 invested and about $10,000 in cash. Jane’s great-aunt Helga passed away and left them $50,000. What should they do?
Owe Own
Car Loans-$30,000 Bank Accts-$10,000
Credit Cards-$10,000 Investments-$50,000
Line of credit-$5,000
Total Consumer Debt= $45,000
Mortgage on $425,000 home- $300,000 (payment is $1500/month)
After telling Joe and Jane to ignore broke friends and family about bitcoin, weed and buying rental properties with small down payments, here is what they need to do:
- Mindset. Realize what a leg up this can give them if used properly.
- Budget. Start doing a written budget for each month before the month begins. After doing a budget, they realize the monthly basic necessities (food, gas, mortgage, utilities) add up to $3200 per month.
- Debt. Pay off all debt except their mortgage…in one day. After the cars, credit cards and lines credit are gone, $5000 of the $50,000 is left, and they’ve added more take home pay now that the debt payments are gone.
- 911. Save up an emergency fund. If their expenses are about $3000 per month, three months of expenses is $9000, and six months is $18,000 (I like round numbers so I would say $10,000 or $20,000). With the $10,000 already in the bank, they settle on $15,000 as their emergency fund in a separate basic savings account.
- With their combined gross income of $100,000 their take-home pay per month is about $6000. With no debt except the mortgage, and basic expenses at $3200, this leaves them $2800 extra per month.
- Invest 15%. 15% of $100,000 is $15,000 per year or $1250 per month, now leaving them with $1550 per month to put extra on the house, save for new cars, trips or even jet skis!
Example #2
We’ll use the same example as above, except now Joe and Jane won $1,000,000 on the lottery (please don’t buy lottery tickets…). Surely my advice will change right? Joe and Jane are rich so special rules apply to them right? They dial 912 instead of 911 like the unwashed masses correct? No. I would tell Joe and Jane to follow the exact same steps as above, but now they can go few steps further.
- Pay off the house early. They are on a budget, no consumer debt, have an emergency fund and are investing 15% of their gross income. With $955,000 of the million left they can pay off their home…in one day. Yes they will pay a penalty to break the mortgage early. We’ll call it $3000. So what? It’s a small price to pay to be completely debt free with a pile of money, essentially a rounding error in the grand scheme of things. Now they have $652,000 of the million left.
- Max out investments. Here is where Joe and Jane probably need to interview a number of financial advisors who are relatively on the same page as them. Anyone who mentions lines of credit real estate nonsense, whole life insurance products, loans or debt of any kind is removed from the running immediately. They finally find one and come up with a plan to max out TFSA and RRSP contributions as well as some non-registered funds. They also buy two rental homes for cash (no mortgage) which nets $3000 per month after factoring in income tax, property tax, maintenance, and vacancies.
- Now they can buy jet skis and go to Mexico!
Easy enough? There’s more than a few opinions out there to confuse the subject and no doubt many will disagree with me. Let’s go through the common pushbacks.
“But mortgage rates are about 3% and I can get 10% with investing, why shouldn’t I invest everything?”
Because you probably won’t get 10% in the near term. You might lose your job. Your house might burn down, you’ll still have the mortgage payments and insurance will take a year to get finalized. With no debt payments how much more cash will you have per month? If you paid off your house and never have a mortgage or rent payment going forward for the rest of your life how much margin would you have?
“But with $50,000 I can put down payments on three cheap rental properties. That’s smart use of leverage to obtain cash flowing assets like rich people do!”
Yes, I’ve seen the flyers for the seminar by the airport Holiday Inn too. I understand the math on how that works, and for some it does. The reality of having tenants and being in a position to fill vacancies quickly so you don’t pay a bunch of mortgages at once drives you too pick bad tenants out of desperation. By using debt to get real estate you drive up your risk substantially and the financial reality isn’t as exciting as YouTube makes it sound.
For example:
Rental Income-$1500
Mortgage Payment-$800
Property Taxes/Ins-$350
Profit So Far-$350
If you report things correctly on taxes, you made an additional $18,000 that year which you pay taxes on. But wait! Can’t you write off almost everything? Mortgage interest, cell phone, home office space, fuel etc? Sure, fine, but write offs don’t equate to massive tax savings. People start making bad strategic decisions to get a write offs. If you spent $10,000 on renovations let’s say, and you are in a 40% tax bracket you get $4000 back and act like you won the lottery but still are $6000 out of pocket! Factor in a new furnace and tenants who trash the place or don’t pay (good luck getting rid of them), and your $350 per month is gone in a hurry. Better to pay tax on a profit then to take a loss to get a write off but you do you.
marksdailydollar.com 