A Practical Guide to Handling your Trust/Inheritance/IPO

Inheritances or career events like a company IPO often bring significant increase in your net worth. When that happens, most people wonder, "what should I do with this?" This guide provides a practical, structured answer to that question.

Step One: Establish Your Financial Goals

The first step in managing newfound wealth is setting clear financial goals. For those in their mid-career, these objectives often include:

• Retirement savings: ensuring you’re able to live comfortably in retirement
• Homeownership: Setting aside money to purchase or upgrade a home
• Debt reduction: Paying off lingering debts like student loans or credit cards
• Philanthropy: Setting aside a portion of wealth for charitable contributions
• Reducing risk: Feeling confident that your assets won’t suddenly lose half their value

Step Two: Diversify Your Investments

If your wealth is predominantly in a single company's stock or one type of asset, like a mutual fund, it's beneficial to diversify. This means investing in a range of asset classes, industries, and geographic locations – like ETFs, Bonds, and Real Estate. Counterintuitively, a diversified investment portfolio is both safer and typically provides better returns than a concentrated one.

Step Three: Manage Your Taxes

Many times, assets you receive through an inheritance or company IPO will have appreciated in value from their “Cost Basis”. When you sell the asset, you’ll owe taxes on the increase in value from what it was previously worth. The most crucial part of managing taxes is setting aside money when you sell the asset to pay for these taxes. You can also do things like selling assets during a year where your income is lower (such as when you’re in grad school or in between jobs) and thus in a lower tax bracket.

Case Study: The Single-Company Equity Dilemma

Consider Alex, who worked for a tech startup that IPO’d and found himself with $300,000 in equity. His wealth was tied up in that single company's stock. His first step in addressing his financial windfall was to set clear goals: #1 keeping money safe to use for a down payment on a house and #2 reducing the risk of that one stock going down.

With these goals in mind, Alex diversified his investments, selling 20% of his shares in his companies stock each quarter and reinvesting that into a broader portfolio of assets including index funds, treasury bonds, and a modest allocation to real estate through a REIT ETF. This new asset mix made his money much safer, while still allowing it to grow over time.

Alongside diversifying his investments, Alex also planned how to manage his taxes. He strategically sold off portions of his company's stock during two different tax years, helping to reduce the amount of capital gains tax he paid by staying in a lower bracket.

Putting it in action: Build your Plan

Now that you have a grasp on how to approach your newfound wealth, the next step is to write out your financial plan. This plan should include sections like:

• Your financial goals
• An overview of your current assets
• Changes you want or need to make
• Next steps

This one-time exercise, taking about an hour or so, can save you tens of thousands in future dollars in reduced fees and reduced risk.

PS: Important Things to Know

There are a few financial concepts that, while not immediately intuitive, are very helpful as you build your financial plan:

• Avoid high financial advisor fees: A 1% fee to a financial advisor may seem small, but over 30 years, they’re taking 30% of your money! A much better option is a fee-only financial planner.
• Steer clear of high-fee mutual funds: Paying mutual fund fees (often 1%) is a complete waste - you get the same returns from ETFs with wasting $ on fees. If you’re invested in mutual funds through a financial advisor, it’s double the cost.
• Picking stocks is a gamble: Selecting stocks that outperform the market is rare, even for professionals. A diversified portfolio of ETFs is typically a safer, better-performing option.
• Timing the market is risky: Trying to predict the highs and lows of the market to decide when to buy or sell is near impossible. Over the long run, your safest bet is to invest or sell today, rather than waiting for a potentially better time.

When you apply these principles, the management of your financial windfall can become a source of security and opportunity rather than a daunting challenge. Good luck!