Lottery Fever and What to do with the Money
With the Lotto Max jackpot reaching $50 million for Friday’s draw, tongues were wagging. Most of my co-workers claim they don’t buy tickets even when the jackpot becomes huge. In a few cases the stated reason is not wanting to have to manage all that money.
It’s certainly true that most lottery winners seem to manage their money poorly. There is no shortage of rags to riches and back to rags stories. So, what would be a good way to handle the money from a $50 million win?
I may not have the best answer, but here is one answer. I would open two discount brokerage accounts and designate one of them the “tax” account. Both the tax and non-tax accounts would get $25 million. Each would hold the same mix of ETFs. One possible mix is equal dollar amounts of each of the following:
XIU, ZCN – Canadian stocks
XBB, ZAG – Canadian bonds
XSP, ZDM – U.S. and international stocks
The idea here is to have the following types of diversity in case of problems:
– 2 separate brokerages
– 2 separate ETF companies (iShares and BMO)
– stocks and bonds (the lower expected returns of bonds vs. stocks is of little concern with so much capital)
At the current dividend yields, the average yield of this portfolio is 2.68%. Every 3 months each brokerage account would get about $167,500.
My simple rule at this point is that I can spend (or waste) the cash that enters the non-tax account in any way I wish. If I feel generous, I can give chunks of it away. The cash that arrives in the tax account is for paying income taxes. At the end of the year anything left over in the tax account that wasn’t needed for paying income taxes becomes free for spending.
The only remaining rule is to avoid ever signing papers that promise future payments. If some friend begs for $250,000, the answer would be that he’ll have to wait until my account accumulates that much. If I want to buy a house, I have to “save up” for it. By never eating into capital or signing papers promising future payments, the money should last indefinitely.
It’s certainly true that most lottery winners seem to manage their money poorly. There is no shortage of rags to riches and back to rags stories. So, what would be a good way to handle the money from a $50 million win?
I may not have the best answer, but here is one answer. I would open two discount brokerage accounts and designate one of them the “tax” account. Both the tax and non-tax accounts would get $25 million. Each would hold the same mix of ETFs. One possible mix is equal dollar amounts of each of the following:
XIU, ZCN – Canadian stocks
XBB, ZAG – Canadian bonds
XSP, ZDM – U.S. and international stocks
The idea here is to have the following types of diversity in case of problems:
– 2 separate brokerages
– 2 separate ETF companies (iShares and BMO)
– stocks and bonds (the lower expected returns of bonds vs. stocks is of little concern with so much capital)
At the current dividend yields, the average yield of this portfolio is 2.68%. Every 3 months each brokerage account would get about $167,500.
My simple rule at this point is that I can spend (or waste) the cash that enters the non-tax account in any way I wish. If I feel generous, I can give chunks of it away. The cash that arrives in the tax account is for paying income taxes. At the end of the year anything left over in the tax account that wasn’t needed for paying income taxes becomes free for spending.
The only remaining rule is to avoid ever signing papers that promise future payments. If some friend begs for $250,000, the answer would be that he’ll have to wait until my account accumulates that much. If I want to buy a house, I have to “save up” for it. By never eating into capital or signing papers promising future payments, the money should last indefinitely.
One problem you might run into in purchasing or even rebalancing the BMO ETF's is liquidity. ZAG and ZDM have net asset values of only $18MM and $63MM, respectively. What is the purpose of splitting your money between 2 ETF companies? I would imagine if one went defunct, the assets would be safe although you'd run into some headaches.
ReplyDelete@J: Good point about the liquidity. If I couldn't get $8 million of each, then I'd have to find some other similar ETF for the balance.
ReplyDeleteI think you answered your own question. I wouldn't want headaches that affect the entire portfolio. If one fund company has problems, I'd still have a healthy revenue stream from the other while the mess was being sorted out.
On the subject of rebalancing, I probably wouldn't bother unless something drastic happened. I'd be too busy wandering around the world enjoying my time.
BMO addresses the issue of their ETF liquidity:
ReplyDeletehttp://www.etfs.bmo.com/ETFConsumer/controller/image?image=True_Liquidity_pdf&lang=en
They seem to say, "Go ahead and buy all you want...we will make more. Ditto for the sell side."
Are they just blowing smoke?
@Andy R: I don't believe they are blowing smoke. Their explanation makes perfect sense. What they didn't say was how long it would take to create or redeem new ETF units. I have no doubt that a big buyer of ETF units could get them, but I'm not sure how long it would take to buy them at a fair price.
ReplyDeleteWe were talking about this at lunch today. Most people agreed they would give some away, to family, friends or charity. I think that's honourable, but it underlines the fact that I'm not sure I could spend that much money. $167,000 every three months is probably also more than I could spend, although more manageable. Maybe I lack imagination.
ReplyDeleteI don't understand why lotteries don't increase the number of prizes instead of the size. I'd rather have a chance at 25 prizes of $2 million (still a lot of money) rather than a chance at 1 prize of $50 million.
@Robert: Once the large sums of money started rolling in regularly, I bet you would come up with ideas :-)
ReplyDeleteI think the answer to why the top prize is so large is clear: more people buy lottery tickets when the top prize is huge. The designers of the lottery are interested in maximizing profits. They care little about what makes a reasonable size prize.
@Financial Cents: I'm pinning my hopes on lottery officials awarding me the prize by mistake. I don't find that buying tickets significantly improves on my odds.
ReplyDeleteThis is a really well-thought out strategy. I just wish this post would be the top result for a Google search "What to do with lottery winnings".
ReplyDeleteIn order to come up with this solution, you have to be smart enough not to dedicate much money to lottery tickets.
@Gene: Thanks for the chuckle. It is indeed a catch-22 of sorts.
ReplyDeleteI'm not sure why you would want to buy ETF with $50 million. Even at XIU's .17% that's 85k/year. Pretty sure you could hire an accountant for less to make transactions for you and monitor stocks that come and go on the exchanges - if you wanted the diversity of the etfs...
ReplyDelete@Anonymous: You'd be surprised how inconvenient it is to have employees that need monitoring. I'd rather pay $85k/year in MER than keep my eyes on an accountant if I had enough money to do whatever I wanted.
ReplyDeleteWith all due respect to the well thought out posts you regularly have, I'd question handling $50 million in this manner. Before retiring, I worked for a high networth wealth management firm and can say from experience, you would get better management of your tax situation, desired returns, legacy planning of the portfolio, consideration of income, risk, and administration, from a reputable investment counsel firm, all for 1 to 1.5% fee (and for that kind of money you have leverage to negotiate). Not to be disrespectful, but the ETF route at this level of wealth would be a gross disservice of the potential you could realize from this amount of capital. Seriously, anyone winning this kind of money should put together a team of tax accountant (tax & estate planning), financial planner (overview--no insurance required if estate planned properly!), lawyer (estate planning--wills, trust), and investment counsel (asset management with custodian holding funds), put a plan in place and execute when the money is delivered. Then disconnect the phone and take a 10 week vacation.
ReplyDelete@Anonymous: Pardon my skepticism, but I can see where giving away $500,000 per year to these many professionals would help them, but it's not clear how it would help me. This represents nearly 40% of the income that I could draw from the lump sum. The professionals would have to demonstrate that they could save me at least this much in taxes to make them useful. I simply don't believe that they could generate greater returns than I would get from the ETFs.
ReplyDeleteFair enough--I understand $500,000 is a lot of money to pay for managing money, however I would point out that ETFs also have both MER and TER, albeit less than 1%. And there are other considerations such as whether you want to hold an ETF or the stocks within in, considering some may have a considerable weighting within the ETF; and how much of an impact you as an individual would have on the ETF value going into and out of positions--someone buying/selling $9 million in XIU is going to affect the market at the time of the trade--I've seen it firsthand on my screen; if you were intent on an ETF strategy for a $50 million holding, then be prepared to spread it over several trading sessions. Also, it was a common practice for us to only put 30% into the market per quarter, holding the remainder in bonds & small percent cash. Entering the market all at once is risky. In our firm, there was no fee until it was all invested and being managed.
ReplyDeleteAs at anytime, you should ensure you get value for your what you're paying. There's is more to managing this kind of money than simply the returns. You want to manage it thoughtfully to ensure you can realize objectives for charitable giving, gifting to loved ones, transition between generations, and of course income in the now. All while minimizing the tax impact now and in the future. Does the average lottery winner have the knowledge to manage that? I realize there's a perception that professionals prey on the average guy, but many have a valuable service and knowledge base to provide--and there are good ones and bad. This costs money. You know that: researching, writing and maintaining a blog takes time and expertise for which, ideally, you'd like to be compensated.
@Anonymous: I agree that professionals can do a lot of clever thing to help their clients. The important question is whether this help would make up for $500,000 per year. The strategy I described involve nothing clever. Just invest the money over a few months in the ETFs and pay whatever taxes are due each year as a result. Anyone who can resist tinkering could do what I described quite easily.
ReplyDeleteI agree that there are many clever things that can be done to be more tax-efficient. But, will they save $500,000 per year? If I were the one with the lottery win, I'd be willing to listen to a pitch from professional wealth managers. But, they would have to convince me with numbers that I'd be further ahead with them than using the simple strategy I described.