Most quick millionaires go bankrupt soon
Large sums of money coming suddenly into your life may make you vulnerable to financial mistakes
The $16 billion Walmart-Flipkart deal came closer home to many Flipkart employees when a letter sent to them listed out the process and price of the employee stock buyback. For those who are current employees with already vested options (see this story to know more about this: bit.ly/2wDOsfC), the money will come in three tranches—half on the date the transaction closes in about 60-90 days, a quarter a year later and the rest at the end of two years from the first liquidation. The letter puts the value per share that the firm will buy back from the vested stock options between $125 and $129. At the current conversion rate, a person holding 10,000 shares will make approximately a pre-tax Rs8 crore.
Sudden windfalls can be exhilarating; it must be quite a trip to see your account balance that has a number with so many zeros. But hold on, research shows that lottery winners go broke in three to five years. It took Sushil Kumar, the Rs5-crore-Kaun Banega Crorepati winner in 2011, just a few years to burn through the cash. From a person who earned Rs6,000 a month pre-KBC, to having a post-tax Rs3.46 crore in the bank, to selling milk from the four cows he bought and some fixed deposits, took just three years.
While anecdotes are aplenty on winners of sudden gain losing it all and going back to where they were or worse, a 2011 paper in the Review of Economics and Statistics gives academic heft to these stories. The paper compares Florida Lottery winners who won $50,000 to $150,000 to small winners, and shows that such transfers only postpone bankruptcy rather than prevent it. Economist Jay L. Zagorsky at the Ohio State University writes that “research shows lottery winners and people getting windfalls spend or blow through much of the money”.
But not all winners burn through their winnings and winning a lottery is a very different story than getting rich on vested stock options. This wealth has come on the back of those 14-hour weekdays, the missed birthdays of spouses, not being there for the important school milestones of the kids and then simply turning around to see that the kids are now almost at eye level. While it is sheer hard work that makes the ESOP (employees' stock option) holders rich, in a sense there is a lottery element to getting rich on stock options. Remember, very few startups survive, fewer get the kind of valuation that makes employees rich and still fewer are those lucky enough to be in the firm at the right time with already vested stock options.
Large sums of money coming suddenly into your life, whether it is from a stock option becoming cash, an inheritance, a sold property, a bonus, or even a matured insurance policy, make you vulnerable to mistakes. There are some basic lessons that the suddenly rich must remember from the experience of those before them. There are four mistakes you must not make with sudden money. One, don’t think of the money as a single number. That opens you up to spending and investment decisions that look to soak up the entire amount. It is always better to break up the amount in your own head. For example, if there are loans that you are carrying—car, home, personal—this is the first use of the money. Breaking it up allows you to sit down and make a plan about the money rather than make an emotional decision. Two, don’t suddenly change your lifestyle and burn through the cash on impulsive lifestyle spends. The itch to spend on a big lifestyle statement is huge. It could be a car or a house or high-end gadgets that lose most of their value as soon as they leave the showroom. Three, don’t fall for investment scams. You are particularly vulnerable to sharp sales pitches and outright fraud. When there is a large sum of money, the sharks circle around even more. The basic financial planning lesson that you must remember is this: if the deal sounds too good to be true, it is too good to be true. Four, don’t lend it away. Money has this habit of attracting people who need it. One way to not see the money every day is to invest it right away in a liquid fund while you wait to decide on your plan.
What can you do? Pay off your loans, and then build an emergency fund. Identify what you need the money for in the future and work through a plan to deploy the money for those goals. But don’t forget to earmark a number to spend on yourself, family and friends. Coming as part of a plan, this spending is going to be guilt-free.
Monika Halan is Consulting Editor at Mint and writes on household finance, policy and regulation