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How To Invest A Lump Sum

{ 34 comments }

If you are asking how to invest a lump sum, you are probably doing a lot better than an average American household and it is a good problem to have. This is a real issue, though, because the situation happens more often than you think. Every week, there seems to be a bunch of lotto winners who don’t know what to do with the lump sum other than taking it to Las Vegas! Well, let’s talk more about normal people like you and me.

how to invest lump sum

Here are some situations where you could come into some money:

  • 401(k) roll over
  • A lump sum pension payout
  • Saved up $100,000 and waiting for a stock market buying opportunity
  • Inheritance
  • Sold your home
  • Law suit settlement
  • Sold a business
  • Sold the art you found in the garage for $30,000,000

See, chances are good that you’ll get your hands on a lump sum at some point in your life. The first order of business is to make sure you have got the basics covered before investing this money.

Cover the Basics

  1. Pay off high interest consumer debts.
  2. Shore up your emergency fund, typically 3-6 months of living expense.
  3. Invest in yourself. This could be setting a little aside for a PhD, attending a conference, or just taking a class.
  4. Optional – pay off/pay down your mortgage.

Once you get the easy stuff out of the way, then you should look into invest the rest of the lump sum. If you don’t have a financial advisor, you probably should at least sign up for a one time financial planning session. Once you figure out your risk tolerance, you can come up with an asset allocation plan.

Everyone has different levels of risk tolerance and financial needs. A 25 year old with 30+ years of pending full time employment shouldn’t invest the same way as someone who has just retired. That’s why we need to have a financial plan before investing that lump sum.

When to invest

Option 1 – Dollar Cost Average (DCA.) Most of us have to invest by dollar cost averaging. Whenever I get paid, I send a bit to my 401(k) and that works well. It’s a familiar strategy and it suits us psychologically. Many studies have shown that we hate losing money about 2X more than we like gains. By dollar cost averaging, we won’t feel too bad if the market drops because we could buy more at a lower price. If you think the market is a bit high right now, then it might be good to DCA that lump sum into the market over a year or so. You could invest 1/12 of the lump sum every month for example.

Option 2 – Go All In. On the other hand, Vanguard recently released a study that shows DCA just means taking risk later. Historically, the stock market rose over time so the more time your money is in the market, the better off you’ll be. (On the average.)

Option 3Time The Market. If you think the market is too high right now, you can try to time the market. I don’t mean waiting until the market has a big downturn before investing. That doesn’t really work according to the experts. The alternative is to modify your asset allocation to be more conservative/aggressive in the short term. For example, I thought the market was heading higher when I rolled over my 401(k) so I went with 100% equity for a few months. Now I think the market is fairly valued so I’m rebalancing my retirement portfolio back to my long term asset allocation.

It really depends on your temperament and time in the market. I think if you have 20+ years to go before you start withdrawing from your investment, then it’s best to just go all in. You still have 20 years left to keep adding money into your investment account and that’s your DCA. Historically, 20 years is plenty of time for the market to rise and make your money work for you.

Wrap Up

I think it’s really important to come up with an investment plan and then just go ahead and invest. The longer you stand on the sidelines, the longer your money is losing value due to inflation. If your lump sum is earmarked for investing, then you should go ahead and get it rolling.

What do you think? Have you ever held a check for $100,000 in your hands? It’s hard to let go at that point, but you don’t want it to just sit around in a savings account earning less than 1% either.

Disclaimer: I am not a financial advisor and I don’t even play one on TV. I’m just a regular Joe investor who consistently added to our stock market investments over the years. If you need help with investing then you should schedule an appointment with a good financial planner. You can also try Personal Capital. Personal Capital is a new site that analyzes and keeps track of all your investment in one place for free. You can also qualify for a free financial review from their financial advisor if your investable assets are over $100,000.

photo credit: flickr Tracy O

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{ 34 comments… add one }
  • The College Investor March 13, 2013, 12:18 am

    A study showed that DCA underperformed just going all in 66% of the time. The only reason it wasn’t higher was the skewed results of really investing at a peak.

    I’m a fan of going all in versus dollar cost averaging. However, if I ever get a lump sum, I’ll probably hold it in cash for a while and slowly make decisions (almost timing, but more about taking the time for myself to research).

    • retirebyforty March 13, 2013, 3:45 pm

      You have a lot of time left to invest as well. That makes a big difference and you should do well.

  • Integrator March 13, 2013, 4:20 am

    I tend to agree that time in the market is better than trying to time the market, especially if you feel the market is fairly valued vs overvalued. If you have a long term outlook, a 1-2% price difference up front will hardly make much difference over 20 years.

    • Mr. 1500 March 13, 2013, 9:33 am

      Agreed. I think its silly to pay attention to market whims, especially when your outlook is long. And if your outlook is short, the majority of your assess allocation shouldn’t be in stocks anyway.

      Bottom line: Don’t time the market. Warren Buffett is more successful than you and he doesn’t time the market. Check out page 6 of his current letter where he discusses this very thing.

    • retirebyforty March 13, 2013, 3:46 pm

      Yeap, and over 20 years, you will probably add a lot more than that lump sum anyway.

  • Glen @ Monster Piggy Bank March 13, 2013, 5:40 am

    I’ve never held a check for that much in my hands, but I did hold one for 35K and that was pretty hard to let go of.

    I regularly use dollar cost averaging, but it can be dangerous if you don’t know what you are doing.

    • glancep March 13, 2013, 6:08 pm

      How do you mean that it can be dangerous? I can’t figure that one out. It seems to me that it would be the “safest” (and simplest, since you don’t have to know anything about the market).

      I know the Vanguard study that was referenced above that showed preference against DCA, but it isn’t by a large margin. And I suspect that if you aren’t in a “lump sum” / “windfall” scenario (like most people, most of the time), you’d be much better going DCA as you have funds available (assuming no/low transaction costs) than waiting until you have a significant amount of money to invest.

  • Money Beagle March 13, 2013, 5:52 am

    I like the fact that you gave other things to consider ahead of investing the lump sum, specifically paying down/off your mortgage. If you come into a big chunk of money and you can pay off 50-100% of the balance of your mortgage, I think it’s a great idea even if you have a low interest rate. It will free up that cash flow, giving you opportunity to invest it anyways or to consider other opportunities that might match with goals in your life.

  • Mike March 13, 2013, 7:07 am

    I prefer the time the market. Research then make your move when you feel that the market is right for the picking. I have other things to do before investing, so it’s important for me to plan ahead rather than have a lump sum ready to invest into the stock market.

  • JC @ Passive-Income-Pursuit March 13, 2013, 7:32 am

    I’d probably go all-in with it but it would be much more diversified. Trying to invest and manage a 6+ figure portfolio is much different from a smaller portfolio, even more so when it’s a lump sum payment.

  • John S @ Frugal Rules March 13, 2013, 9:08 am

    I’d probably go all in with the lump sum. With rates these days you’ll be better served to put it into the market and try and earn more there. I would go with some solid dividend payers plus some index funds to boot. Thankfully the only debt we have is our mortgage and might pay that off too.

  • Steve March 13, 2013, 9:10 am

    There are two questions here.

    How to invest a lump sum: All in. DCA and market timing are worse performance for more effort.

    What to do with a windfall: Well that’s a different question. Answer: It depends.

    • retirebyforty March 13, 2013, 3:48 pm

      Good point, I struggled a bit combining the two and probably should have made it more clear.

  • Kurt @ Money Counselor March 13, 2013, 9:56 am

    My feeling is that if the only way you could persuade yourself to invest is through DCA, then your risk tolerance is likely too low to be sinking money into that investment in the first place!

    I’d definitely apply a lump sum to debt, including the mortgage. Then I might invest in other costly projects that would pay long-term benefits and reduce my fixed costs, like adding solar panels to my house, putting in an electric vehicle charging station in my garage, or installing a tankless water heating system in my house. Finally, I might invest in a local small business, rental property, or other venture–something I’m knowledgeable about. Sorry, equities would not be on my list. 🙂

    • retirebyforty March 13, 2013, 3:50 pm

      Really? Many people like DCA and it works for them. I guess older investors who has more experience are more gutsy and have an easier time going all in. Thanks for your reply. It’s nice to know equities aren’t for everyone.

  • Thanks for laying out the options so clearly! Great post.

  • Patrick March 13, 2013, 11:02 am

    I once held a check (actually it was wired to my bank) for 200K. This was based on the sale of my personal website that I had started from scratch.

    Taxes vaporized 40K. Ouch. So I took the remainder to an investment adviser and they have managed to produce something like 12 percent or even a little more based on the last 14 months. But of course the market just keeps going up, so I jumped in at a good time.

    I had no debts and I rent for $425/month, plus I have no dependents. I continue to work to pay my bills. Have never touched a penny of the principle or the interest + dividends yet. Don’t plan to either, for quite some time.

    Currently building my next business. I already get RB40 via RSS, think it’s a great site! Cheers.

    • retirebyforty March 13, 2013, 3:51 pm

      Oh wow, 200K! That’s a lot of money for a blog. I hope RB40 will be worth that much someday (or more!) 🙂
      Thanks for subscribing.

  • Nick March 13, 2013, 1:16 pm

    I would pay off my mortgage before pursuing a PhD, but that is just splitting hairs. 🙂 Great post!

  • krantcents March 13, 2013, 2:54 pm

    Good points! You might add a life insurance check to your list. I would like any lump sum in the form of cash (singles would be nice) so I can enjoy it. Only kidding! I only a few opportunities to receive huge sums of money and I quickly invested them.

    • retirebyforty March 13, 2013, 3:52 pm

      I wonder what the bank would say if you request $100,00 in singles. 🙂

  • For the first time ever, I should get a 6 figure check this month when my practice sells, if we don’t experience any more delays. This post comes at a great time. I’ve struggled with what to do, but probably it will go toward debt so we can start using our income for other investments.

    • retirebyforty March 14, 2013, 9:34 pm

      Congratulation! Hope it clear without any problem.

  • Jane Savers @ The Money Puzzle March 13, 2013, 7:48 pm

    I have never experienced this type of problem but I think that I would lock the money in a GIC (guaranteed investment certificate – like a CD) for a few months so that I could make a plan that I could live with that wasn’t fueled by the adrenalin rush of sudden wealth.

  • My Financial Independence Journey March 14, 2013, 6:31 am

    Timing the market becomes way less important if you try to find the best valued securities within the market at the time you have the money.

    If I inherited a small stash of money I’d probably just dump it into more dividend paying stocks ASAP. Just making a larger purchase rather than my regularly scheduled smaller purchases.

    If I inherited a large stash of money, I’d spread it out a bit more. It would still all be going to dividend paying stocks, but I’d probably try to invest it over the course of a year, so that I have sufficient time to research all the investments. This is a function of time to research and properly allocate than any desire to DCA.

  • Kevin @ RewardBoost March 14, 2013, 7:41 am

    There’s another name for timing the market: gambling.

    In today’s economy with rapid money printing going on at the federal reserve, I think the best way to preserve wealth is to spend it on things like property. Dollars aren’t always necessarily going to hold value, but homes will.

  • SavvyFinancialLatina March 15, 2013, 9:07 am

    I think it’s all about diversification.

    Our strategy is to have diversified life 🙂 401k in stocks, ROTH IRA in stocks, our future home, real estate possibly in the future (like a rental home or duplex?), a small business, taxable investment account.

    Right now, we only have my 401K and ROTH IRA, but are planning to add to it in the future.

    • retirebyforty March 15, 2013, 4:34 pm

      Great plan. I’m sure you’ll do very well over the next few decades. 🙂

  • Diane March 16, 2013, 10:26 am

    So, I retired in December. In late February, I finally decided to get off my duff and roll my (former) company’s 401k into my existing retirement account, for which I use a financial advisor. Of course, while my funds were being processed, and effectively out of the market, said market performed spectacularly. (Insert sound of palm smacking forehead. Repeatedly.) My only consolation is that the majority of my funds were still fully invested, but why, oh why, couldn’t I have put it off a month longer??

    I realize that in the long term, it won’t really matter all that much, but it sure smarts right now!

    • retirebyforty March 18, 2013, 4:35 pm

      Sorry to hear that! At least you were in the market from November to February. The market did very well in that time as well. I hate having my 401k fund out of the market too.

  • Felix Lee March 17, 2013, 7:58 pm

    These are great suggestions. I think about these and see what should be the best for me.

  • Shawn James @ PipsToday March 17, 2013, 11:00 pm

    Great Post! I have invested money in forex and stock money that’s my short term investment. I am agree with your point “it’s really important to come up with an investment plan and then just go ahead and invest”. If you plan to invest your savings, it’s required to write an investment plan but it’s simple to do this if you just think about what you’re saving for and when you’ll need the money that’s important.

  • Investment Total August 18, 2014, 7:02 am

    This is a very useful post. I think he’s just a humble man, he’s experts in finances. I am agree with what he said about lump sum investing, the more you invested longer, the more money you gain. Time is important than timing. Keep up the good work.

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