Now I have won the lottery: what should I do with the money?

Andrei Boar
Teacher Assistant of the Finance, Accounting and Control Dept. 
__

On December 22, the Extraordinary Christmas Draw is held annually in Spain, with prizes ranging from 20 to 400,000 euros per ticket. Winning the lottery is always a reason to rejoice, since it guarantees an extra cushion of money, but it is necessary to maintain a cool head and analyze what to do with the economic amount obtained. 

If nothing is done with the money earned, it will lose value over time, especially at a time when inflation is hovering around 5%

Firstly, it must be taken into account that in Spain the prize must be taxed only if it exceeds 40,000 euros, after which the tax exemption ceases to apply and 20% of the amount received must be paid. For the Christmas lottery, the first, second and third prizes should be taxed, which, with the liquidation of taxes, would add up to a net value of 328,000 euros, 108,000 euros and 48,000 euros, respectively. The rest of the prizes do not require taxation.

Once the tax issue has been settled, it is necessary to evaluate what to do with the money. If nothing is done with it and we put it in the savings account, the money would lose value over time, especially at a time like the present when inflation is hovering around 5%. 

What do we do with the money?

Let's assume that inflation is 2% per year -the ECB's target- over the next 10 years. In this situation, the value of the first prize would be 268,000 euros. To avoid this reduction in value, there are different investment options to consider depending on the level of risk you want to assume. The higher the risk, the higher the return and, therefore, a higher profit (or loss) can be obtained. Below, we present some options that need not be chosen in a unique way, since the most important thing among investment alternatives is diversification.

There are several investment options depending on the level of risk to be assumed: the higher the risk, the higher the return, but also the greater the risk of loss

Thus, for more conservative investors, the main exits are:

• Bank deposits in which the financial institution keeps our money. The profitability of these products is currently close to 0%.
• Fixed income. This consists mainly of investing in public debt or corporate debt in exchange for interest. In the case of Spain, the yield on 10-year debt would be 0.36%. In the case of Germany, for example, it is -0.26%. If you are willing to assume a slightly higher risk, large companies issue debt of between 1% and 2%.

For the more daring investors, we find alternatives such as:

• Variable income. The investment is an important alternative to value, although in the short term it may seem highly volatile. The American stock market, for example, has accumulated an annual return of nearly 8% since 1927. The Spanish Ibex-35, on the other hand, would be an index to avoid, since there are stock exchanges such as the American, French or German ones with clearly higher yields. Only in 2021, the Dow Jones rose by 23% over the previous year, the CAC 40 by 25% and the DAX 30 by 13%, while the Ibex-35 rose by only 3%. It should be noted that these values are higher than the historical average, since Covid-19 had a strong impact on the indices in 2020.  
• Private Equity or investment in start-ups. At this point, the returns can be very high, but so is the risk, since it is investing in companies that are just being born or are growing and therefore do not yet have a consolidated position in the market. Another issue to take into account is the difficulty of recovering the investment, since it would only be possible if another investor decided to buy our stake. In case you want to diversify the risk, there are options such as crowdfunding, where small investments (usually 3,000 euros) are pooled from different investors to meet the financing needs of the company. 
• The cryptocurrency market. This last option is only recommended for investors willing to take extreme risk and only for a limited investment. Currently, there are about 15,000 cryptocurrencies in trading, but the queen is Bitcoin, which from an initial value of $196 in 2013 has reached $66,000 this year. Although the profit is clearly higher than the other alternatives, so are the losses. In this market it is common to see falls of up to 50% in a few days. 

Leaving aside the type of investors, an alternative that deserves a separate mention is that of housing. The purchase of real estate can have variations: if it is a residence to live in (a second home, for example), it must be assessed whether we will be able to maintain it over time. If it is only an investment, the expected annual return would vary between 4% and 7% in cities such as Madrid or Barcelona.

Diversification and distance from money are key factors in managing economic investments

Be that as it may, winning the lottery is a reason to rejoice, but it is necessary to analyze coldly what one wants to do with the prize, since, if not, with time the value is lost by itself. In any of the above options, diversification and distance from the money are the key and, as a general recommendation, in order not to lose the value of the prize, the return obtained should be higher than inflation.