All posts by Financial Independence Hub

Managing a Windfall: Sudden increases in Net Worth and how to handle them

Image courtesy Pexels/Tima Miroshnichenko

By Devin Partida

Special to Financial Independence Hub

The initial excitement of suddenly receiving an inheritance, lottery win or large bonus is palpable, presenting what seems like endless possibilities. However, this euphoria gives way to the daunting reality of managing significant amounts of money.

You face complex decisions that involve managing your new wealth responsibly and planning for your future in ways you might not have considered before. This transformative moment calls for careful consideration and strategic financial planning to ensure your sudden wealth leads to long-term security and success.

The Reality of Sudden Wealth

Many people believe sudden wealth is a one-way ticket to lifelong happiness, but the reality is far more complex. Despite the number of U.S. adults in the upper-income tier rising from 14% in 1971 to 20% in 2019, managing significant financial resources introduces many new challenges.

You might think money will solve all your problems, but it often brings issues, including increased responsibility, potential isolation and the need for meticulous financial planning. Instead of viewing wealth as a simple solution, recognize it as a valuable tool requiring savvy management to benefit your life. This approach ensures you handle your finances wisely, considering the intricate balance between enjoying your wealth and maintaining it for the future.

Understanding the Psychological Impacts

When you receive a sudden windfall, confusion and stress quickly cloud the initial rush of joy as you face unexpected financial decisions. People sometimes refer to this whirlwind of emotions as “sudden wealth syndrome” — a phenomenon that can lead to anxiety, poor judgment and hasty financial decisions.

Taking deliberate steps is crucial to maintaining emotional stability. They include the following:

  • Pause and allow yourself time to adjust
  • Consult with a financial advisor and tax expert
  • Seek support from professionals or support groups

These help you manage your new circumstances wisely and guarantee you make the most of your windfall without emotional turmoil.

Practical steps to manage a Windfall

Create a budget tailored to your new financial situation to manage a sudden windfall adeptly. Start by calculating your net worth to gain a clear understanding of where you stand money-wise. Before making any major decisions, place your funds in a temporary, safe location like a high-yield savings account to ensure they remain secure while you explore your options.

Additionally, take the time to educate yourself on financial management and investment strategies. Enhancing your knowledge in these areas will empower you to make informed decisions that align with your long-term financial goals. This proactive approach will help you maximize the benefits of your newfound wealth.

The Importance of a Structured Financial Plan

A comprehensive financial plan is essential to manage and sustain your wealth effectively. Harness the power of technological advancements like AI and machine learning, which can predict upcoming financial trends and assess investment risks precisely. Moreover, seek the expertise of professional financial advisors who can tailor a plan specifically suited to your unique needs and goals. Continue Reading…

Conquering Retirement Fear: from Apprehension to Adventure

Many dream of retirement, but as the big day approaches, some experience a surprising emotion: fear. Billy and Akaisha Kaderli, your guides to navigating retirement, delve into the anxieties that can lurk beneath the surface of financial preparedness.

RetireEarlyLifestyle.com/iStock

By Billy and Akaisha Kaderli

Special to Financial Independence Hub

All of your ducks are in a row.

You have saved and carefully invested for years, and the personal discipline is about to pay off.

So why is there apprehension in the bottom of your belly? Let’s be honest. There is risk involved, and the future no longer seems certain or familiar.

“What if I forgot about something?” you think, and start going over every plan you have made.

No one likes to admit straight out that they are afraid of retirement. Why, that sounds silly. But changing your life from one of being focused on work duties, raising a family, paying bills, and receiving that dependable paycheck every week to one of the virtually unknown has its own set of stresses. You’re being dishonest if you say it’s not a big leap mentally, emotionally, or financially.

Lack of confidence often underlies questions disguised as logistics on how to retire. Sometimes, one must simply take the leap of faith, making a companion of the ever-present question “What if?”

If you have spent your whole life building security and providing that same security the best you could for your family, then stepping into the unknown world of retirement is like jumping off a cliff.

Even if you’re as prepared as you think you are.

Sure, we can distract ourselves with dreams of endless golf, or margaritas on an exotic beach somewhere, but when it’s quiet, we find ourselves looking over our shoulders, wondering whether some forgotten component is lurking just out of sight.

What if I run out of money?,” you whisper to yourself.

Perhaps your personal fear-mongering nemesis is health care in retirement, your portfolio balance or even something as simple as boredom. There can be great comfort gained from all of one’s time being planned out months in advance.

Going sailing, Boracay, Philippine Islands

Going sailing, Boracay, Philippine Islands

To expect retirement to be free of hitches or snags is unreasonable. There are no guarantees in life. None of us knows what the future will bring, and this is true whether you’re working or retired. Continue Reading…

Capital Gains Tax Increase? This new Calculator helps Corporation and Trust accounts

 

By Ted Rechtshaffen, CFP

Special to Financial Independence Hub

As you may know, the recent Federal Budget announcement had a few important changes that can have an impact for some, but certainly not all.  The most discussed has been the increase to the capital gains tax.

The most directly impacted are those with investments in a Corporation or a Trust.  Not only will they face an increase in taxes on every dollar of capital gains (not just after $250,000 as it is on personal accounts), but this is forcing some important near term decision making.

For many people in this situation, the question for investments with unrealized capital gains is whether to hold those securities longer term or sell them prior to June 25th to avoid the new higher tax rate.

To help with that choice, we have just launched a new calculator aimed at this group.

It is free for anyone to access.  They don’t have to provide any details.

The calculator can be found at New Capital Gains Tax – Sell or Hold Calculator – TriDelta Private Wealth

Continue Reading…

Private Equity Returns

Image via Pexels/Markus Winkler

By Michael J. Wiener

Special to Financial Independence Hub

One of the ways that investors seek status through their investments is to buy into private equity.  As an added inducement, a technical detail in how private equity returns are calculated makes these investments seem better than they are.  So, private fund managers get to boast returns that their investors don’t get.


Private Equity Overview

In a typical arrangement, an investor commits a certain amount of capital, say one million dollars, over a period of time.  However, the fund manager doesn’t “call” all this capital at once.  The investor might provide, say, $100,000 up front, and then wait for more of this capital to be called.

Over the succeeding years of the contract, the fund manager will call for more capital, and may or may not call the full million dollars.  Finally, the fund manager will distribute returns to the investor, possibly spread over time.

An Example

Suppose an investor is asked to commit one million dollars, and the fund manager calls $100,000 initially, $200,000 after a year, and $400,000 after two years.  Then the fund manager distributes returns of $200,000 after three years, and $800,000 after four years.

From the fund manager’s perspective, the cash flows were as follows:

$100,000
$200,000
$400,000
-$200,000
-$800,000

So, how can we calculate a rate of return from these cash flows?  One answer is the Internal Rate of Return (IRR), which is the annual return required to make the net present value of these cash flows equal to zero.  In this case the IRR is 16.0%.

A Problem

Making an annual return of 16% sounds great, but there is a problem.  What about the $900,000 the investor had to have at the ready in case it got called?  This money never earned 16%.

Why doesn’t the fund manager take the whole million in the first place?  The problem is called “cash drag.”  Having all that capital sitting around uninvested drags down the return the fund manager gets credit for.  The arrangement for calling capital pushes the cash drag problem from the fund manager to the investor.

The Investor’s Point of View

Earlier, we looked at the cash flows from the investment manager’s point of view.  Now, let’s look at it from the investor’s point of view.

Suppose the investor pulled the million dollars out of some other investment, and held all uncalled capital in cash earning 5% annual interest.  So the investor thinks of the first cash flow as a million dollars.  Any called capital is just a movement within the broader investment and doesn’t represent a cash flow.  However, the investor can withdraw any interest earned on the uncalled capital, so this interest represents a cash flow.

The second cash flow is $45,000 of interest on the $900,000 of uncalled capital.  The third cash flow is $35,000 of interest on the $700,000 of uncalled capital.  The fourth cash flow is a little more complex.  We have $15,000 of interest on the $300,000 of uncalled capital.  Then supposing the investor now knows that no more capital will be called and can withdraw the remaining uncalled capital, we have a $300,000 cash flow.  Finally, we have the $200,000 return from the fund manager.  The total for the fourth cash flow is $515,000.  The fifth cash flow is the $800,000 return.

The cash flows from the investor’s point of view are

$1,000,000
-$45,000
-$35,000
-$515,000
-$800,000

The IRR of these cash flows is 10.1%, a far cry from the 16.0% the fund manager got credit for.  We could quibble about whether the investor really had to keep all the uncommitted capital in cash, but the investor couldn’t expect his or her other investments to magically produce returns at the exact times the fund manager called some capital.  The 10.1% return we calculated here may be a little unfair, but not by much.  The investor will never be able to get close to the 16.0% return.

Others have made similar observations and blamed the IRR method for the problem.  However, this isn’t exactly right.  The IRR method can have issues, but the real problem here is in determining the cash flows.  When we ignore the investor’s need to be liquid enough to meet capital calls, we get the cash flows wrong.

Conclusion

Some argue that we need to use the IRR method from the fund manager’s point of view so we can fairly compare managers.  Why should investors care about this?  They should care about the returns they can achieve, not some fantasy numbers.  Any claims of private equity outperformance relative to other types of investments should be taken with a grain of salt.

Michael J. Wiener runs the web site Michael James on Moneywhere he looks for the right answers to personal finance and investing questions. He’s retired from work as a “math guy in high tech” and has been running his website since 2007.  He’s a former mutual fund investor, former stock picker, now index investor. This blog originally appeared on his site on Feb. 15, 2024 and is republished on the Hub with his permission. 

Gold glitters amid Persistent Inflation and Rate Uncertainty

Image courtesy BMO ETFs/Getty Images

By Chris Heakes, CFA

(Sponsor Blog)

Gold prices have gained more than 14% since late last year, renewing market interest for the precious metal.

Recent gains have been driven by an expectation that the U.S. Federal Reserve (Fed) is getting closer to reducing its trendsetting overnight rate, which led to a weaker U.S. dollar index to close 2023.

In recent months, inflation concerns have ramped back up with recent U.S. CPI data coming in slightly ahead of expectations. While consumer prices continue to trend in the right direction, higher shipping costs are becoming a concern with cargo ships having to avoid the Suez Canal. Shipping costs have surged 150% as a result, potentially add 0.5% percentage points to core inflation1: and re-igniting worries that CPI could accelerate again.

These developments have created a favourable environment for gold, given bullion tends to be used as a multi-purpose hedge for portfolios.

BMO Global Asset Management has launched a gold ETF that is backed by physical bullion. This ETF stores physical 400-oz. bars, secured in a local vault operated by BMO. Investing in the new BMO Gold Bullion ETF is efficient for investors as it is listed on the Toronto Stock Exchange (TSX) and trades like any stock or ETF. Additionally, since the underlying bullion holdings are professionally vaulted, investors do not have to worry about safe-keeping on their own. The BMO Gold Bullion ETFs are available at a cost-efficient management fee of 0.20%.

The BMO Gold Bullion ETF

Benefits

  • Amid reaccelerating inflation concerns and interest rate uncertainty, gold could be used as a defensive hedge.
  • Macro as well as weaker-U.S. dollar risks have risen in recent years, and could remain elevated going forward.
  • Gold offers effective diversification from stocks and bonds, which have experienced a notable rise in correlation3.

Why Gold could continue to Glitter

Gold is often used to hedge three main risks: macro-economic/geopolitical and inflation risks, as well as against a weaker U.S. dollar and fiat currencies4. All of these risks have risen in recent years and it is quite possible and perhaps probable that they will remain elevated going forward, spurring further demand. Continue Reading…