Ah, a lump sum investment - we all dream about it, don't we? We all plan out how we would spend our lottery winnings or inheritance. The truth is, though, that a lump sum investment is more likely to be a result of a redundancy, insurance settlement, or accident compensation. At the time when you get your lump sum investment, you are likely to be stressed and distracted, and you are at risk of making poor investment decisions.
Making lump sum investment decisions can be intimidating. Even if you have past experience with making investment decisions, the scale of a lump sum investment makes it a whole new ball game. It is a good idea to step back and carefully consider your lifelong investment plan before making your lump sum investment decisions.
What kind of returns are you looking for?
Do you want to use this lump sum to provide your day-to-day living needs? Perhaps you have other sources of income, and you are intending to grow this lump sum investment for the future. Do you want the lump investment to provide a regular, secure income for you? Maybe you want to accumulate the lump sum investment via capital growth, so that you can pay off your mortgage at retirement, or live on the income from the lump sum investment at a later date.
The priority of investment income vs capital gains will make a big difference to how you invest your lump sum.
How much risk are you willing to take?
Financial advisors often refer to your risk tolerance - this is not so much a measure of your psychological state, although that is a factor, but more to the stage you have reached in your investment strategy. Returns always come with risks when you are investing, and higher returns come with higher risks. If you have a higher risk tolerance, you can aim for higher returns - but be prepared for losses. Younger investors can afford to take more risks, because tehy have more time to recover their losses. If you are within a few years of retiring, you need a more conservative strategy for your lump sum investment.
How active can you be in managing your lump sum investment?
Some investments require more active involvement than others. Make sure you have the required knowledge if you choose an active investment - and make sure you have the time required to monitor your lump sum investment. Entering into active investments without the required time and knowledge is a dangerous path. If you are in a position to be actively involved, you may enjoy a lump sum investment in commodities or options. Otherwise, you may prefer the peace of mind of a managed fund - you will have to pay fees, but you gain the services of a professional fund manager.
We all think we'd "have it made" if we suddenly had a lump sum investment drop from the sky. Sadly, many people who receive compensation payouts or lottery wins end up broke again within a few years. The way you handle your lump sum investment will determine the course of your life for decades to come. Make sure that you exercise caution and due diligence, and make the right choices for your lump sum investment.
This article is an extract from Mark Bennett's comprehensive guide on lump sum investing, which is available from AllFinanceAdvice.com.
Mark Bennett is a staff writer for AllFinanceAdvice.com, and publishes regularly to other reputable financial websites and publications.
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Comments: 6
Step 0 is optional - spend 10% of the lump sum in anything he/she chooses. Just blow it.
1. Put the lump sum in a safe money market fund
2. Build up 3 to 6 months in expenses and set that aside in another money market account not easily accessible
3. Pay off all of that individual's consumer debts (including car, student loan, credit card, etc.)
4. Cut up all credit cards and switch to a debit card (put some spending money in checking account)
5. If money still remains, fund amount needed into adequate retirement fund
6. If you have kids under 18, fund amounts needed into adequate college fund
7. Pay off mortgage
8. Invest a portion of the remaining money into 2 or 3 no load, low expennse mutual funds that will grow (depending on the age of recipient) - example is S&P 500 index fund.
If a competent and trustworthy financial adviser is near, ask for help, but be mindful of the fees and commissions charged. 1% to 2% of expense fee can have a huge impact in the long run.
I'm debt free (mortgage too), and loving it. I am choosing NOT to participate in this recession.
I agree that if you have the money, paying off a student loan is a good thing to do, especially if your income is not secure. On the other hand, if you have just acquires a lump sum, and you have a secure income which is gradually paying off your student debt, you may be able to pay it off faster by investing the lump sum and feeding teh returns into the student loan along with your normal payments - and when the student loan is paid off, you still have the lump sum investment paying you an income.
It really comes down to one's individual risk tolerance, and the importance of the other psychological benefits of being completely debt-free.
Very timely article for me Mark. I have a childhood friend that deals Trust Deed Investments. (his site)
He doesn't know, but I recently came into a nice chunk of change and I'm looking for something that isn't Wall Street related (for obvious reasons, lol), I'm thinking about throwing the money his way and telling him to invest it for me into trust deeds. Do you have any advice on this?