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