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September 12, 2018 Article 4 min read
Good news: you’ve received a financial windfall. But, don’t go planning that luxury vacation just yet. Here’s what you should do first.

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Getting a financial windfall is always a nice surprise, whether from a work bonus, inheritance gift, or if you’re really lucky, lottery winnings. It’s tempting to immediately think of all the fun things you could spend it on. But, an impulsive purchase could negatively impact your financial future. This isn’t to say you shouldn’t use some of it to have fun. But, before you do, make sure you’ve got the following financial bases covered.

1. Consider the big picture and create a personal balance sheet.

Take the example of a 38-year old who has a $300K mortgage, $20K in student loan debt, and $250,000 invested. What should they do with a $30,000 bonus? The answer is, it depends — on things like debt interest rates, how much they have in cash reserves for emergencies, and where they’re at on the path toward financial independence/retirement savings.

Before you make any decisions regarding a large influx of cash, you’ll need to determine where you stand financially. Start by creating your own family’s personal balance sheet. Gather relevant information such as life insurance policies, loan information, and retirement and brokerage account statements. Subtract the sum of your liabilities (e.g. mortgages, credit card balances, taxes owed) from the sum of your assets (e.g. cash on hand, investments, home value) to arrive at your overall net worth. A wealth manager can help with this step.

Before you make any decisions regarding a large influx of cash, determine where you stand financially. Start by creating your own family’s personal balance sheet.

2. Prepare for a rainy day.

If things are going great in your financial world, now is the best time to make sure you’re ready for emergencies, such as health issues or job loss. Dual income couples should have three months’ worth of savings; individuals or couples with one working partner should have six months’ worth. Don’t rely on your memory or intuition to determine what one month’s worth of expenses is; instead, run the numbers. Check bank statements or electronic financial programs to determine your discretionary and nondiscretionary expenses. Then, you can more readily create a simple budget and start planning how to save/invest for your goals for the future.

Dual income couples should have three months’ worth of savings; individuals or couples with one working partner should have six months’ worth.

3. Compare interest rates.

Conventional wisdom would say you should pay down debt from loans, mortgages, and credit cards, prioritizing the highest interest rates or lowest debt amounts before making any other financial moves. And, there’s reason for that: paying down debt is a good thing, especially when talking about credit cards or high interest student loans. But, prioritizing debt repayment isn’t always the best decision, especially if your financial situation is more complex. For example, say your only debt is a 1.9 percent car loan and 3.5 percent mortgage, and you’re invested in a diversified portfolio in a brokerage account that has the potential to earn 5 to 8 percent over the long term. Rather than paying off the entire car loan, it could make sense to continue making payments on it, and invest the excess cash.

4. Evaluate insurance and risk management needs.

Like emergency savings, insurance can help you protect your assets. Take a look at the balance sheet you prepared in step 1, and make sure your liability insurance would cover all of the assets you listed in a worst-case scenario. Situations like disability, death, and disasters aren’t pleasant to think about, but not doing so can cause more pain down the road. If you’re married or have children at home, pay particular attention to life insurance. Many companies offer it, but the policy you have through your employer may not be enough for your family’s needs in the event of a tragedy. It’s also very important to consider what type of life insurance to buy. Term insurance is a cheap and effective way to insure against a large risk in the short-run, but whether or not it’s right for you depends on your particular situation.

5. Revisit savings goals.

Retirement may still be decades away, but your future self will thank you for making it a key component of your financial plan. This is another situation in which hard data can help you make the best decision. You’ll need to project what your financial situation will look like when you’re no longer working. You can use online retirement calculators to get an idea of what your savings should look like or find a good independent financial planner that can help you project out the goals. Although a lot of this is simple math, an effective financial plan is as much an art as it is a science. Depending on how close you are to retirement, you might want to adjust your contributions up or down, making sure you’re taking advantage of any employer match to your 401(k) plan. If you’re over 50, consider contributing additional “catch-up” amounts.

Another consideration is whether a traditional IRA or Roth IRA is a better target for additional savings if you’ve maxed out your 401(k) plan. Even though there are limitations based on income, there still could be a way to get money into a Roth IRA over time, even if you’re over the income limitations. Still have remaining cash? Apply it to children’s college funds and health savings accounts.

If you’ve received a windfall, have taken all these steps, and feel confident about your financial position, reward yourself with those fun purchases you’ve been thinking about. If not, start saving toward them; the reward will be knowing you’ve made the right moves to secure a bright financial future.