Navigating Sudden Wealth II

One of our primary client demographics is sudden wealth. Sudden wealth occurs when a client experiences a significant increase in their wealth, such as winning the lottery, inheriting a large sum of money, or going through a divorce from a spouse who kept separate finances. In each of these scenarios, you wake up one morning and realize you are significantly wealthier than you were the day before. Interestingly, it’s not just the actual acquisition of wealth that can trigger this realization. Sometimes, it’s simply the recognition that you have attained more wealth than you ever thought you would. We’ve seen this with someone close to retirement who reviews their retirement options and realizes that the "set it and forget it" strategy they adopted a few decades ago worked very well.

Now that we’ve defined sudden wealth, what do we know about the behavioral and cognitive biases they exhibit? And, by extension, what can we do to help them navigate this reality? Depending on one's history with money, we have found that individuals exhibit one of two biases. The first is recency bias. This bias causes our brain to believe that whatever has been happening recently will continue in the future. An example of this is if the market has been in correction or possibly even a bear market, that it will continue in that direction. Even though every day the market is down, the likelihood that it will reverse trend increases, people suffering from recency bias tend to believe that it’s best to just sit on the sideline and avoid being invested. Market timers tend to suffer from this bias. It might also manifest in excessive risk-taking or poor impulse control with cash flow. The idea being that this new wealth will always be there, regardless of their poor stewardship of that money.

The second bias we often see in people experiencing sudden wealth is overconfidence bias. This is a tendency to overestimate one’s abilities to make investment decisions. We saw this a lot back in the early 2000s. Imagine a young professional working at a tech startup. A big part of their compensation was their company’s stock. It goes public, and these young people are instantly millionaires. The history of those few years is filled with these folks ignoring the advice of advisors to diversify their holdings, to reduce exposure to the tech sector. When that giant aberration in IPO history ended in bankruptcies and tears, many of them realized that what made them great tech workers didn’t make them great stock pickers.

Can you overcome these biases without the assistance of an advisor? Sure, the internet has a ton of resources to help you. What we do for our clients when we determine these biases are present is start to educate them on the bias and how it is showing up in their behaviors and decisions. Utilizing robust planning software, we can model out the consequences of those biases if left unchecked. Partnering with them through investment management decisions and working through choices with an eye to taxes, longevity risk, and cash flow analysis are all part of our modus operandi. In some cases, clients sign over all investment decisions to us and give us complete discretion on investing the wealth for their benefit. We follow a fiduciary standard throughout the financial planning engagement by treating each client as a dynamic individual with very specific needs, allows us to service our clients at a level that exceeds their expectations.

Any opinions are those of Gary Hoenig and not necessarily those of Raymond James. Past performance may not be indicative of future results. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. You should discuss any tax or legal matters with the appropriate professional.