Sun, Dec 24, 2006 page12

• Facing a windfall? Careful how you interpret that pot of gold

  Behavior econnomists believe that people place their cash in separate `mental accounts' and this dictates subsequent use

  • NY TIMES NEWS SERVICE
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  Yul Kwon just won US$1 million on the television show Survivor. What's he going to do with that windfall?

  Kwon, a Silicon Valley business strategic consultant, is showing the same intelligence and restraint that helped win him the money after 39 days on a South Pacific island.

  "I have tried very consciously not to get too ahead of myself on what to do," he said in an interview this week. "I plan on sitting on the money for a while so I can get my feet on the ground. I don't want to be rash about it."

  It turns out that this is the single best piece of advice someone with a windfall can get. Many financial planners, at least those who have not immediately outstretched their palms, tell people who have unexpectedly received a large sum of money -- whether it is a lottery prize, an inheritance, capital gains from a stock or a house sale, or yes, game show winnings -- to do nothing initially.

  If you do get lucky, the pause gives you a chance to think about the money, about yourself and how you relate to money, said Susan Bradley, a financial planner who runs a boot camp, called the Sudden Money Institute, for those with newfound wealth.

  "Six months is not too long," she said.

  Giving more advice on how to deal with a windfall is difficult because there are just too many variables, like how much it is, what form it comes in and how much you already have. Then there are the technical issues like how it affects your income taxes or the income taxes of the people who might share your largess.

  wrapped in emotion

  But behavior economists, and a few psychologists, have been thinking about this issue for some time and they have useful ways to approach it. People think of money in odd and sometimes irrational ways because money is wrapped up in emotion.

  People tend to put their money in three mental accounts: income, assets and future income, behavior economists say. How much of it they spend depends on the mental account where the money is "placed."

  Almost all money considered income is spent, though the conscientious may divert some of that into the two other accounts. Money regarded as future income is rarely touched, except in emergencies.

  The middle category, assets, is trickier. That gets spent depending on a person's age -- the young need to spend a lot and the old do not spend enough of it -- and on the person's needs, a down payment for a house, for example, or seed money for a business.

  Windfalls are so overwhelming for most people precisely because they can be dumped into any one of those mental accounts.

  If it is a small windfall relative to income, people tend to think of it as income and spend it all. What about those US$23.9 billion in bonuses that the Wall Street investment bankers are receiving?

  They get mentally sorted into the asset pile, so it is no surprise that real estate agents and luxury car dealers are salivating at the prospect of a few quick sales of multimillion-dollar condominiums, vacation homes and trophy cars.

  Windfalls that occur when a stock jumps in price tend to go into the asset pile, too. Sitting there, they have little impact on behavior. Michael Hurd, the director for the Rand Center for the Study of Aging in Santa Monica, California, studied the impact of a windfall in the stock market on people nearing retirement. He found there was no evidence that people changed their plans and took an earlier retirement.

  That could be because the stock gains were not enough to make a difference to most people who are not heavily invested in the market, he said. As for the wealthy who are, the gain does not make that much difference because they are already rich.

  Hurd also looked at the effect that the disappearance of an anticipated windfall would have on those who thought they could retire early. Not surprisingly, there was a behavior change. They tended to retire later or went back to work if they had already retired.

  exception

  Home equity loans are an interesting exception. People tend to keep the gains from a home in the same category. Even when homeowners extract equity, the money tends to be used to improve the home, in other words, reinvested into the same mental category as an asset or as a source of future income.

  Lotteries are a different animal, Hurd said.

  "You'd see more behavior change because the reward is spread to people who don't have big resources," he said.

  A quick detour with a bit of advice on lotteries, just in case all this talk of windfalls has whetted your appetite for some easy money:

  If you are buying a single ticket when the pot gets above US$100 million so you can enjoy two minutes of user-generated entertainment as you daydream about servants, Ferraris and playing bridge with Warren and Bill, it can't hurt.

  Buying several tickets or buying every week is not, however, the basis of a sound retirement plan. Lotteries are a waste of money.

  So into what basket is Kwon sorting his US$1 million?

  "I am thinking of it as income flow," he admitted, even though he does not have a lot of money saved.

  Debt from college at Stanford and law school at Yale can do that.

  The money is as good as gone, not that that is necessarily a bad thing. He also wants to do something for his parents, who he said made a lot of sacrifices as he was growing up.
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