In a few hours, or perhaps, a few days, some lottery players will become very rich. Those who win close to $1.5 billion dollars in Powerball and Mega Millions jackpots, that is.
That’s certainly a great deal of money. But holding onto money made quickly and spending it wisely is often more difficult than acquiring it.
That’s why financial advisors have plenty of tips for lottery winners, from hiring an experienced attorney to paying taxes, and to developing an investment plan.
But there’s one tip that stands out: lottery winnings shouldn’t be treated differently than money acquired in conventional ways, e.g., by work — because there’s the risk of losing part or all of it very quickly and ending up broke.
Behavioral finance has a good explanation for this. It concerns mental accounting, which —unlike traditional accounting— causes individuals to treat different kinds of money differently.
How? By taking on higher risks, as is the case with dollars won in a casino or dollars gained in a stock market bubble.
This same mentality affects people who never gamble, explain Richard H.
Thaler and Cass R. Sunstein in Nudge.“When investments pay off, people are willing to take big chances with their winnings. For example, mental accounting contributed to the large increase in stock prices in the 1990s, as many people took on more and more risk with the justification that they were playing only with gains from the past few years.”
That’s why financial experts recommend a couple of things to avoid falling victim of mental accounting with lottery winnings. One of them is not to rush to spend the money. “Don’t make any quick decisions. Embrace the power of saying ‘no’ to all of the requests that will come your way,” says financial adviser Kathy Longo, CFP. “It’s extremely important to find purpose in your life that extends beyond money.”
Another thing to do is set aside a fixed amount to enjoy. “One of largest problems lottery winners have is spending it all in the first couple of years. Then they usually end up worse off than before,” says Alex Graham , President of Graham Capital. “So, I’d recommend working with your financial advisor to determine what is a safe amount to go splurge on dining, shopping, travel, or whatever your heart desires. Then keep the balance to live off the income generated by those investments with an emphasis on tax qualified investments that can further help your tax bill.”