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If I had a million dollars…(or $31 million)

by | Oct 9, 2013 | SELF-PUBLISHED

Three principles of financial planning for millionaires (and wannabes)

What would you do with $31 million? It’s a common fantasy question at coffee break or around the water cooler when government lottery jackpots reach eye-watering levels. A recent Lotto 649 jackpot was around $31 million. LottoMax winnings have often gone to $50 million. But for those few who are lucky lotto winners, or for those who have inherited a pile or more commonly earned it the hard way, the real question isn’t how to spend it…it’s how to keep it. I advise clients who have asked me this (and, yes, there are people in this rarefied group) always to start with three key planning principles.

1. Preserve your capital

Whether you have a nest-egg of $500,000, $1 million, or $31 million, believe it or not, your biggest challenge isn’t about how to spend it. Your big challenge is how to keep it from being nibbled to death by ducks. Capital has many enemies, but three of the biggest systemic ones are inflation, taxes, and macroeconomic forces. By “systemic,” I mean capital-destroying factors that you don’t directly create yourself. They’re part of the wider world over which you have no control. Your approach to these realities is purely defensive.

For example, the $31 million lottery winner starts to lose purchasing power as soon as that gargantuan sum is transferred to their bank account. Statistics Canada reports that Canada’s annual inflation in August was 1.3% when food and energy prices are excluded from calculations. Doesn’t sound like much, does it? But on $31 million, that’s a loss of purchasing power of $403,000 in a year.

Then, there’s taxes. Okay, let’s say that on the advice of your bank, you temporarily put your $31 million lottery winning into 1-year Government of Canada Treasury bills, which were recently yielding 1.03%. So over a year, while you decide what to really do with your fortune, you’ll receive $319,300 in interest income. Being interest income, that will be taxed away at the top marginal rate, say around 50%. You’re left with $159,650.

Eagle-eyed readers will see right away that the yield here is less than the current rate of inflation (1.3%) for the same period. So assuming inflation remains roughly where it is now, in terms of purchasing power over the next 12 months, your return would be $157,574 after taxes and inflation. And don’t forget, your original capital tied up in T-bills has also lost purchasing power in the meantime.

As for macroeconomic events, like market-shaking financial crises, U.S. government shutdowns, geopolitical tensions in the Middle East, and so on, these can evaporate your capital in a heartbeat (never to be seen again) if you’ve made some ill-considered asset allocation decisions. But more about this in Principle Number 3, below.

You see what I mean about your capital being nibbled to death by ducks? And it doesn’t matter how many zeros we’re talking about for your nest-egg here. Move the decimal place to the left, and the story is the same one.

When you’ve built up (or been handed) a tidy nest-egg, preserving it is job one.

2. Control your spending

Any idiot can spend money with reckless abandon, and most idiots do. We’ve all read stories or seen documentaries about winners of huge lottery prizes who end up on the dole in a few short years. “How is it even possible to blow $31 million?” we all ask, usually with more than a little stunned disbelief. Actually, it’s pretty simple. Think about it: When you don’t observe Principle Number 1 above, all those yachts, private jets, exclusive vacation villas, luxe homes and cars for family and friends, and hobnobbing with the high-flyers will drain that $31 million pretty fast.

Even those high-earning, high-net-worth individuals who made it the hard way to lucrative professional careers, making $1 million or more annually, often find themselves in a cash flow bind, always “broke,” with creditors banging on the doors.

Whether you’re a bazillionaire or a just plain high earner, uncontrolled spending will – not “can” or “might,” but “will” – make you feel like you’re always broke.

A sensible financial plan will bring that under control, relieving you once and for all of that sense of impending financial doom. Those big lotto winners, for instance, would do well to take, say, 20% or 25% of their winnings and blow that any which way, just to celebrate and get it out of their system. On a $31 million prize jackpot, that comes to $7.75 million you can burn. Then apply Principle Number 3 to the balance.

3. Make it grow…efficiently

Capital preservation for that nest-egg is all-important, but as we’ve seen, it just isn’t all that easy. With larger amounts, it becomes commensurately more of a headache.

To preserve your wealth and keep it working and producing for you, you have to make some key decisions about your tolerance for risk and from there how to allocate those assets in the most tax-efficient way possible.

We’ve already seen the futility of abandoning large lump sums to so-called “risk-free” vehicles as a capital preservation strategy. Even if the temptation is just to leave it in a bank or other deposit-taking institution, you will soon run up against the maximum amounts allowable for Canada Deposit Insurance. So even here, what you might think is completely “risk free” really isn’t.

For those larger nest-eggs, it’s important to diversify assets over a number of classes (including fixed-income, equity, and alternative investments) using a variety of strategies, including hedge funds, venture capital, private offerings, tax shelters, and other vehicles for “accredited” investors,” to ensure both capital preservation and tax-efficient growth to keep that income stream coming.

If this sounds like gobbledygook to you, you’re not alone. Sophisticated tax and investment strategies that can make this all work are definitely not a “do-it-yourself” proposition. A skilled financial advisor who can tap into a network of opportunities for high net worth individuals is essential here. And so for such individuals, getting the right advice right off the bat could well be Principle Number 4.

© 2023 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.

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