Warren Buffett: What Smart People Do With a Huge Financial Windfall (GameStop Edition)

Warren Buffett is known for making smart decisions. One is to say no to just about everything. Another is to hire the right people.

Another is deciding whom to marry.

So what would Buffett say if you were among the scores of investors who made tens of thousands of dollars in profits — or even millions, if you believe some reports — when the recent, Reddit-fueled rally caused GameStop and AMC Theaters stock prices to soar?

Here’s some advice from the Oracle of Omaha, along with a little of my own.

Once you sell a stock and turn a paper gain into a real gain, your profit is considered income — and unlike with a paycheck, there’s no withholding.

The good news? If you bought and sold, say, GameStop this month, the tax bill won’t come due until April 22, 2022.

The bad news? Those profits are considered short-term capital gains, meaning they’ll be taxed as income. (To qualify for the long-term capital gains rate that maxes out at 20 percent, you must have owned a particular stock for at least a year and a day.)

Depending on your current financial situation and the amount of profit you made, that could mean paying around 10 percent on your windfall — or as much as 37 percent, plus a 3.8 percent net investment income tax if your profits and income combined are high enough.

So yeah: You could pay over 40 percent — and that’s just federal tax.

So talk to an accountant and put sufficient money aside.

Because few things are more certain than taxes.

You may be tempted to use the remainder of your windfall to make more investments. (After all, look how well you did with GameStop.)

First, though, pay off your credit cards. As Buffett said last year, “If I owed any money at 18 percent, the first thing I’d do with any money I had would be to pay it off. It’s going to be way better than any investment idea I’ve got.”

Recent windfall notwithstanding, it’s unlikely you’ll do better than Buffett over the long term. Besides: Paying off high-interest credit card debt is like receiving an instant return on the investment.

401(k) and traditional IRA contributions are tax-deferred. If your windfall will push you into a higher tax bracket, funding those accounts will let you shelter some that money; the larger the windfall, the more likely you’ll be in a lower tax bracket when you make withdrawals at retirement.

As for investing that money? Buffett suggests and investing your 401(k) and IRA savings in an index fund. 

Now it’s time to have a little fun. 

Just make sure you decide on what you’ll spend before you start spending. Pick a number you’ll stick to. Then create a plan.

For guidance, consider some of the ways the happiest people spend their money, backed by considerable science. (Hint: To buy time and experiences, especially with people they care about and enjoy.)

Feeling pretty clever for how you rode the GameStop train? You should.

But don’t assume you can do it again. Your bet — because face it, it was kind of a bet — could just have easily not paid off. Only in hindsight could anyone have predicted what happened.

Denying the role of luck is due to hindsight bias: The tendency to feel that an event, after it happens, was predictable. That every plan was perfect. That every vision was clear. That every step was executed flawlessly.

And that you can replicate your success. As Buffett says, “It’s easier to look back than it is to look into the future.”

Maybe, sometimes, you actually can. But don’t bet everything on it. While your windfall can relatively quickly and “easily,” that doesn’t mean you should treat it cavalierly.

Today, right now, it’s yours.

So if you like, set aside a portion of your remaining windfall for higher-risk investments.

As for the rest? Follow Buffett’s two rules of investing:

Rule One: Never lose money.

Rule Two: Never forget Rule One.