So somehow you ended up with a large sum of money, maybe $25,000, $50,000, $100,000 or even a quarter million dollars. Maybe you got an inheritance, cashed in a retirement account, or sold a piece of property. Maybe you’ve had an investment account for a while that someone else was managing and you’ve taken it over for yourself. Regardless of how you ended up with the money, invested properly it can grow and add to your income for years to come. Here are the things I would do if I came into some money:
1) Pay off debts and get on a solid financial footing.
When I manage my money, I try to minimize the risk of really bad things happening – like losing my home to a foreclosure – while taking prudent risks to maximize return. To maximize safety, I pay down debt and truly own the things that are important. The first thing I would do with a large sum therefore is to pay off any credit card debt because I would know that there is no way I could earn enough return on the money to make up for the interest I would be paying on credit cards. Paying down credit cards is like investing at a guaranteed 15-18% (or more), which means you would double your money about every three and a half years.
While paying off credit cards would be a no-brainer since the interest rates were so high, personally I would also pay off any other consumer debts that I had. In some cases the interest rates are low enough that from a purely mathematical point-of-view I could make more money keeping the loans and investing the money, but I just don’t like having the risk of loans sitting over my head in case the market crashes right at the time I lose my job. I would therefore pay off student loans just to get that part of my life behind me and not have them around when my kids were getting ready for college. I would also pay off any car loans outstanding and make the promise to myself that I would never have a car loan again, not so much because the interest paid is so great but because having a car loan makes me make bad financial decisions like buying cars from car dealers and buying new cars every few years instead of used cars at half the depreciation each year. (Note, I actually don’t ever carry any credit card debt, and I haven’t had a car loan in fifteen years.) I might even pay off the home loan just to not need to worry about losing my home, but that would be a personal choice that really doesn’t make mathematical sense in today’s low-interest rate environment.
Getting rid of these debts would allow me to take more risks with the money I was investing, so I could get a better return. If I don’t have payments to people each month I could drastically cut back on my spending if I needed to due to losing my job. While many people like to keep money-in-hand rather than pay off debts, if you can actually eliminate payments you don’t need to have as much cash-in-hand.
2) Take care of Obligated Investments
Everyone, except those who die young, will need to have money for retirement someday. I would therefore plus up my retirement accounts if I was behind where I should be for my age. This might take a number of years due to the limits on the amount you can contribute to retirement accounts each year, but I would set aside some of the money specifically to contribute to retirement each year until I was fully on track. I would also fund private IRAs for myself and my spouse up to the limits.
I would put money into kid’s college accounts since that expense will come in a few years and I’d want to get tax-free growth as long as I could. Segregating the money into specific college accounts would help to make sure the money was there when they needed it.
Finally, I would create specific investments for things like car repairs, home repairs, and medical expenses. I would lump these things together into one account since they don’t typically occur all at the same time. I would figure out the average amount I would spend on car repairs and home repairs each year, add in a sum to pay for a new roof and a new air conditioning unit, add in an extra $10,000 to pay for a major medical expense, and put that amount into one or two low-cost index mutual funds. I would then leave that money alone to grow so that it would be there when one of these needs appeared in the future and replace the money as fast as I could when some of it was spent. I wouldn’t dip into this money for little things that I could cover with my regular monthly budget – just the big things.
3) Invest for financial independence.
If I’d funded the accounts above and still had money left to invest, I’d use this money to invest for financial independence, that magical situation where I wouldn’t need to rely on my work for support because I’d have enough income from investments to cover expenses. I would put a good portion of the money into broad-based mutual funds. For example, if I had $50,000 remaining to invest I might put $20,000 into a large cap index fund and $20,000 into a small cap index fund. This is assuming I didn’t need this money for at least five to ten years and therefore could leave it alone to grow with the economy.
With the final $10,000, I would find two companies that I thought had a history of increasing earnings and plenty of room to grow and expand. I would put $5,000 into the stock of each company and then plan to hold for several years as the company expanded and grew. If one did very well and it got to the point where the position was very large, (maybe $50,000 or more), I would see some shares and put the money into mutual funds. Otherwise I would leave it alone to grow.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.