Line up 50 humans and each one might have a different definition of "a large sum of money." For some, it's a modest lottery winning or IRS tax refund. For others, it's Grandma leaving them $100K or the sale of a business that nets a million bucks. In any case, falling into extra dough can put more stress on a relationship than catching Mommy kissing Santa Claus (or that hot bartender). Having a plan can make things roll a bit more smoothly.
Pay Off Debt
While paying off debt does not sound like an investment strategy, the U.S. Securities and Exchange Commission argues that you could not make a better or less risky choice. If you experience a windfall and have high-interest debt, particularly on credit cards, pay it off with your new fortune. Gradually paying down debt with interest rates in the teens or higher simply offsets, and often dwarfs the return you can expect to see on most investments.
Contribute to a College Fund
If you have a kid, have one in the oven or plan on consummating your relationship sometime soon, it's time to think about college. When your child makes its triumphant debut on Earth, cut the cord and promptly open a state-sponsored 529 plan. You can use your lump sum -- whatever the amount -- to get a serious jump on rising college costs. While plan specifics differ from state to state, you can generally put around $200,000 into most accounts over the course of your life. And, if you use the money to pay for higher education expenses, the IRS does not tax account earnings. You can invest in any state's plan, regardless of where you live.
Invest in Mutual Funds
You could always use the lump sum to create or improve a diversified portfolio of investments. For many investors, mutual funds are the way to go. They can get you exposure to stocks and bonds, without the pressure of having to make individual picks and manage so many different moving parts. For some, an index fund or two is all that's needed, particularly if you think the broader markets are headed higher over the long term. Index funds look to mimic the returns of stock market indexes such as the S&P 500 and Dow Jones Industrial Average. If you're already in funds, a lump sum of cash might afford you the opportunity to get into top-performing mutual funds with high minimum initial investment requirements. Some of the best mutual funds in recent times require anywhere from $3,000 to $100,000 to get in. Here's your chance.
Dollar Cost Averaging
A big question for people who stumble upon a lump sum of money is whether to invest it all at once or over time, a strategy known as dollar cost averaging. There is really no definitive answer as to the way you should choose. Dollar cost averaging tends to be a bad deal if your investment of choice appreciates consistently. When this happens, you miss out on these returns, while a portion of the money that could be in the security sits on the sideline. If your pick drops in value, putting in a little bit at a time, whether on a monthly basis or in two transactions over a year, tends to pay off. Consider investing the windfall over time if you would like to have some hanging back in case you run into a situation, such as job loss, illness or a major expense, where you desperately need it.
- U.S. Securities and Exchange Commission: Lump Sum Payouts: Questions You Should Ask Yourself Before You Invest a Dime
- U.S. Securities and Exchange Commission: An Introduction to 529 Plans
- Bankrate: The Best Way to Invest a Windfall
- The Motley Fool: The Best Way to Invest a Lump Sum
- SmartMoney: 13 High-Minimum Funds With Solid Returns