Won the Lottery? (Part 2)

Learn How to Not Be Broke Again Three Years from Now!

Hello! David J. here again with more of the steps on my journey to financial independence.

When last we met, we started discussing what to do with lottery winnings, a big bonus, profits from a real estate deal, or some other large sudden windfall of cash. Even if you're only starting out with your own savings, these steps can help you protect and grow your savings into income for your retirement.

If you haven't seen the first part of this discussion yet, take a look at that, then continue here. Or, go back and review it if you have seen it, then come back here and we'll finish up.

Today, we'll continue our discussion with Steps 3 and 4.

I am blessed to be connected to a group where financial education is available - education of a calibre about which the average college student can only dream. This is from my learning, not my experience.

I'm going to propose a four(4) step process:
Step 1: Asset Protection
Step 2: Debt Reduction
Step 3: Income Production
Step 4: Wealth Preservation

Note that I am not a licensed financial professional and am NOT authorized or qualified to give financial advice. This is, again, from what I've been learning. Please take it as such.

I may cite numbers over the course of what follows. Please do not take them as either accurate or "gospel". I'm typing this entirely from memory - what I've learned as I understand and remember it.

We resume our discussion at Step 3.

Step 3: Income Production

After Step 2, you should still have the bulk of your new found wealth remaining. Here, we begin to create our new reality with it.

There are many vehicles available for income production. One of them is money lending. Most folks think that's just the province of wealthy bankers. History shows that, traditionally, this is not the case and that one of the ways people build wealth from modest holdings is by "renting out" their money.

It will help here to acquire some small understanding of how banks work in the 21st Century.

Banks don't actually lend out their depositors' money. Instead, the amount of money they have on deposit determines how much they can borrow from "the Fed", usually at a ratio of circa nine(9) to one. That is, for every dollar they have on deposit, they can borrow nine(9) dollars from the Fed. Sometimes, the ratio can be as high as eleven(11) or more to one. So The Fed's money is partially secured. Think of it this way: as a bank's depositor, you make the "down payment" on the loan the banks get so they have money they can lend out. This is the TRUE meaning of, "It takes money to make money."

The Fed charges the banks interest at a very low rate - on the order of 0.25% - relative to what banks charge each other for borrowing ("the prime rate") or what the banks charge to individual consumers who borrow from the bank - circa 4% to 5% for secured loans, and anywhere up to 30%+ for credit cards and other unsecured loans.

The banks borrow from "the Fed" at a very low interest rate, and lend it out to borrowers at much higher interest rates. This is sometimes called "arbitrage".

So, you will want to emulate the bank's model. That is, "arbitrage" your money: lend it out for more interest than you're paying on your combined debt load.

These investments will, therefore, be short-term investments - six(6) months or so, generally not more than twenty-four(24) months, though some loans may go longer.

A premier option for income production is self-directed tax-advantaged accounts like IRAs, 401(k)s and 403(b)s. Genuine self direction allows that you can direct your custodian to invest your funds in any non-prohibited transaction as defined by the U.S. Tax Code - the "I.R.S. Code".

Some examples of these investments would be a sibling's business, a nephew's financial endeavor, an associate's real estate deal (fix and flip, rehab, etc.), and so on.

Note that I specifically did NOT mention stocks or other "risky" investments. Most folks do not consider the stock market to be inordinately risky. These are some of the same folks who lost half or more of their retirement savings in the crash of 2008 / 2009.

Prohibited transactions are generally those which would benefit you personally, directly. This includes your own real estate deals and financial endeavors, those of your spouse or those of your parents, grand-parents, children, grand-children, etc. ... that is, anyone in a direct line of descendency from you or to you.

Your tax attorney, accountant or other financial professionals as well as your custodian should be able to help you avoid prohibited transactions. You may need to shop around for people sufficiently knowledgeable to assist you in these regards.

Money held in accounts without such retrictions CAN be used to invest in vehicles which WILL benefit you personally. So that's an option for lottery winnings and other sudden windfalls.

Something I would advise against is having dealings with anyone who will benefit financially from any transaction you may make even if you lose money on the transaction. Such people make their money by handling those transactions for you and are not motivated to help you make a profit. Apologies to any financial planners, stock brokers, etc. who may feel slighted by those remarks. No personal attack or offense is intended.

Step 4: Wealth Preservation

This where most lottery winners make their mis-steps and end up broke again in short order: they fail to distinguish between short term gains, and long term income and wealth preservation. Many people buy into the notion that, "If I could just get ahead I could stay ahead".

Wealth preservation is not about spending, it's about having your money working for you instead of you working for money.

Really, wealth preservation becomes a product of Income Production. The idea is to have your income-producing assets increase in value to the point that your income stream is assured for as long you can reasonably expect to need it. They should produce income in excess of your needs so their value increases over time in turn producing greater income to keep pace with inflation and your own needs, which may increase as you age and your health requires more and more attention.

It's not my goal here to suggest income producing assets, though one vehicle I've already mentioned in passing - being a private money lender - can be a strong part of any such strategy. Income producing real estate is another example. Among those who have achieved financial independence - the topic of this blog, the most common "denominator" is wealth produced through real estate holdings.

In summary...

Whether you win the lottery, inherit a fortune or sell a fix-and-flip or rehabbed home for a big profit, your wealth strategy cannot begin with "avenging" all the years of deprivation you've felt being a member of the workforce.

Your wealth strategy has to begin with protection, continue through growth and through debt reduction and be anchored in preservation and income production for as long as you need it.

Re-invest your profits to keep the value of your business growing.

We'll talk again soon!

Take care - be well!

Much Success!