Manage windfall gains
Here are a few ideas on how to use a large sum judiciously.
Most people are careful with their hard-earned money, but when it comes to wind fall gains there is a tendency to splurge it. Though the behavioural aspects behind the spending habits of Indians have not been mapped in a formal study, several surveys conducted in the US have revealed that almost one-third of those who won a lottery ended up seeking some sort of bankruptcy relief within a few years. Here, we have identified a few steps that would help you manage your lump sum gains judiciously.
After all it's your money
The unanticipated nature of windfall gains is responsible for the way it is spent or invested. Many people view a windfall as `found money' and treat it differently than money that they earn, such as salary and profits from businesses. They don't seem to understand that an unexpected income, such as the annual bonus your company pays during the festivities or your income tax refund from the IT department, is nothing but a part of your own hard-earned money. Similarly, the money raised through selling of your ancestral property should never be seen as a windfall. The next step is to convince yourself that even windfall gains, such as winning a lottery, is as valuable as the money you have earned through sheer hard work. If the amount is big, most financial planners would advise you to stash it in a safe place for 3-6 months before taking the final call on what you would like to do with it. This, however, does not mean that you do nothing with it. Instead of leaving it idle in a savings bank account, invest in a liquid fund and evaluate your options slowly.
Tax planning
Some of the money that comes your way may be tax-free, while others may be taxable in your hands. While the big amounts that you receive by way of provident fund withdrawals or gratuity amount will be tax free if you complete five years with the same company. There may not be much of a problem with your annual bonus because what you get in hand from the employer is the amount after tax deduction. However, if you are working as a consultant, and it is only the TDS that was deducted, then you would have to pay the remaining taxes yourself. If the sudden gains is from sale of assets, find out how much of that is capital gains and the tax rates applicable on it.
Repay debt
Repaying debt is one of the best ways to use a windfall. However, here again, you need to distinguish between different types of debt. You should immediately repay high-cost debts, such as personal loans or credit card outstanding and debts taken to buy depreciating assets, such as a car or white goods. But, what about housing or educational loans, where you get tax benefits?
One way is to leave them alone, the other is to make a partial repayment. Fully prepaying the mortgage debt on a self-occupied house may not be a good decision, but you can make a partial repayment and bring it down to the optimum amount of mortgage debt of `30 lakh to 40 lakh. The interest on self-occupied homes is exempt up to `2 lakh, and at 10% interest rates, `20 lakh loan is enough to generate that. We are suggesting a slightly higher optimum mortgage loan because the outstanding loan will keep coming down over the years.
Revisit your goals
If there's anything left after repaying your debts, it can be considered for investments or meeting some of your other goals. Says Anil Rego, CEO, Right Horizons: All unanticipated income should be invested or should be allocated to upcoming goals.
For example, if you were planning to buy your own house in, say, five years, a windfall may allow you to fulfil your dreams in advance. Similarly, you could allocate this money for your child's higher education, that you were planning to fund through loans, three years away. In this case, the allocated amount could be invested in some debt funds for the duration.
Don't splurge
While it is perfectly fine to meet your goals with windfall gains, resist that temptation to splurge. Just because you got a lump sum, you should not buy something which you do not need or cannot afford to own or will not be in a position to service in the future. Also be realistic with costs involved with the purchases. Most people have a tendency to buy one mega house just because they got a large sum. This move may be detrimental because it can exhaust the entire money you received and, therefore, jeopardise your other goals. Some may even end up taking a bigger loan to maintain the house. Buying a bigger car is another common mistake people commit. In addition to the cost of the car, other costs associated with it, such as maintenance, insurance, petrol bills, etc., may incur additional costs that you would have to bear.
Be conservative
You have also got to be careful while investing the money. Be conservative and don't risk or gamble away the luck you got. The biggest mistake people make is to invest without considering their risk appetite: While they may be conservative with their hard-earned money, they tend to take considerable risks with windfall gains. Don't invest everything into one asset class, whether it be real estate, equities or debt. Also, don't invest in the stock market at one go: First invest in a liquid fund and transfer small amounts regularly to equity funds using the systemic transfer plans (STPs).
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