If you took my advice and hired a fee-only adviser, then the question of how should you invest is something they should help you with. However, because I know a lot about this subject, I’ll give you my thoughts and you can double-check my advice with what they tell you. If we’re both saying the same thing, then you can have confidence that you’re on the right path.
Everyone is going to have different goals when they win the lottery. Winners are in different life stages, as well as different geographic locations, therefore the advise is not always the same. Where you put the money should be custom tailored to your goals and objectives.
The main options you have is something like this:
- Put it all in the bank. This is probably a bad option for those living in the western world in this present age. In the past, you could get 3-5% interest from your bank by parking your money there. In today’s low or negative interest rate environment, you’ll get practically nothing or even get charged interest if you live in Europe. A bank is a safe place to put the money temporarily, or a portion of it (say up to a year or two of living expenses), but putting it all there is not advisable.
- Give it all to an insurance company and get a return on the money while you are living as well as a death benefit for your heirs. This is life insurance called whole life. Typically this is not your best option if you are young, as the insurance companies and insurance salesmen take out a big chunk of high fees for products like this. In the previous post I recommended staying away from advisers who charge high fees. However, if you are getting along in years, this might be a very good option because of an income tax loophole. Some whole life insurance pays out an annual dividend that is tax free. That’s great. However, all life insurance pays out the death benefit tax free. That means when you die that your heirs can get the money without paying any income taxes. This is a big deal if you are worth millions upon millions and your kids are going to owe up to 40% in federal income tax (and possibly more with state income tax)! Even though the fees are high in an insurance product like this, the tax savings may more than overcome them. There is some risk with insurance companies these days and without getting too complex here, low interest rates are bad for insurance companies. Some could go bankrupt if interest rates stay low for a long time. If you were serious about this, at least spread the policy over several companies in case one goes under. Or, don’t put all your money in life insurance.
- Bonds. For a long time (say from the 1700s to the mid 1900s) the saying went “gentlemen prefer bonds.” Stocks were considered too risky and more like gambling, therefore if you wanted to invest your money you bought bonds. There are various flavors like corporate bonds (say from Coca-Cola or Apple or some other company), municipal bonds (say from your city, school district, or state – generally tax free if you buy some from the same state you live in), treasury bonds (from the U.S. Government, other countries have different names for them), mortgage-backed bonds (these are full of mortgages from people’s houses or office buildings), high-yield bonds (these are like corporate bonds but are from very low quality companies that may not be able to pay you back). In today’s low interest rate environment, generally this is not a great time to be buying a lot of bonds. If you are OK living with 1-3% interest (and paying lots of taxes on that interest unless it’s a municipal bond) then maybe it’s OK. However, if you are young I think you should only put a portion in bonds, if any at all.
- Stocks. It is true that stocks were very risky for a long time. There was all sorts of fraud and manipulation out there in the 1800s and early 1900s. There were no mutual funds or index funds so buying lots of stocks for diversification was difficult and expensive. However, after lots of trial and error, we have a ‘relatively’ stable and functioning stock market in the present day. Because of regulation, we can generally trust what’s going on behind the scenes. There will always be bad people out there, but we’ve generally figured out how to keep those bad people from blowing the whole economy up. If you are young, buying stock index funds will most likely be the highest paying investment you have available to you. Over the long term of course. I’m talking like 20, 30, 50 years. I am 36 and if I won the lottery, almost all my money would be invested in stocks and stock index funds. If I had $10 million dollars after taxes, I could buy the S&P 500 index fund and get about 2% dividend yield today. That would give me $200,000 per year in dividends (taxes could be up to 15% on that $200k). Each year, unless there’s a complete market melt-down, those dividends increase. So my $200k annual income would increase over time. By the time I’m 75, I might be making $1 million per year in dividend income and that S&P 500 index fund might be worth $50 million. It’s hard to beat that kind of a deal. I’ll probably go into much more detail on this in a future post.
- Real Estate. If you are the kind of person that is more comfortable with investing in real estate, then this is probably where most or all of your money will end up. Just don’t over-leverage yourself. If you are worth millions, there’s no sense in risking it all on a leveraged up real estate deal. You can pay cash for income properties or put down 50% and still live a comfortable lifestyle. If you live out in the country and grew up on a farm, you may want to take your winnings and buy a farm or ranch that makes money from what it produces. Once again, don’t over-leverage yourself here. Lifestock and commodity prices fluctuate all over the place. If you won the lottery you have no idea if prices are at a top or at a bottom. No sense taking your $10 million in winnings, buying a $100 million farm only to lose it all in a few years when prices crashed and you couldn’t make the payments on the note.
- Private Businesses. There are those people out there who don’t have a clue about the stock market, bonds or real estate. But they run a successful business (or multiple businesses). If you are the kind of person who does this, and you win the lottery, probably the best place for your money is in what you already know. Go out and invest that money in your current business or buy another business you like. Run it well and reap the rewards. Just don’t go crazy and over-leverage yourself. I’ll be looking for your face on Forbes in the future.
What should you not invest in?
- Gold, guns, panic shelters and other end of the world scenarios. If the end of the world is truly here, it won’t matter what you have. It’ll all be gone anyways along with everyone and everything else. If you’re going to do something like the Permanent Portfolio, then holding 25% of your money in gold is part of the plan. However, anything more than that is a waste. Gold doesn’t provide you any income, and where are you going to store $50 million in gold? If the semi-end-of-the-world scenario plays out, and you are the only guy within 200 miles that has land, food, guns and gold, how long do you think you can hold out before the masses overtake you? When 50,000 people hear that Joe Prudent has everything stashed away in his shelter, you won’t want to be anywhere near that shelter when they come knocking at the door.
- Your family member’s business idea. Cousin Frank just knows he can become the next Bill Gates with his brilliant plan to sell insect protein to hipsters. All he needs is several million dollars to do it. This is a bad idea. I don’t care how close you are to the guy, and I don’t care if you owe him for saving your life when you were 5. Don’t invest money in business plans for family members unless you’ve done it before – a lot. Startup companies are extremely risky investments (even with PhD’s running them), you would need to invest in at least 30-50, and more like 100, for you to have a reasonable chance of doing well. That means if you had $10 million, you couldn’t invest more than $100k in any one business idea. Generally you should stay away from this unless you’ve done it before, and done it well. However, if you refuse my advise, at least keep it to a max 1% of your money for each business plan.
- A complete stranger needing your money to develop a shopping mall in Florida. You shouldn’t invest in people you don’t know, you shouldn’t invest in things you don’t understand, so if both of these scenarios apply stay away! This is the quickest way lottery winners can blow away their savings.
Most likely, your financial adviser will have you investing in a diversified portfolio of stocks, bonds, real estate and perhaps some to a life insurance policy. If you are adamant about investing in others’ ideas, I would advise capping those investments at 10% of your net worth. That means if you are worth $10 million, the most you would invest in others is $1 million. And like I said before, that $1 million should be spread across 30-50, if not 100 ideas.
A diversified portfolio should give you about 2-4% in annual income in today’s environment. If you are worth millions, that should be enough to live off of without ever having to sell portions off to fund your lifestyle.