Here's the thing about being on the receiving end of a lump sum of money. For starters, it's a financial shot in the arm that leaves you better off.
Secondly, it comes with a unique set of issues, especially including what to do with the money.
The temptation may be to spend it, or spend a large chunk of it. But that's missing a grand opportunity to take a big pile of money and turning it into a bigger pile of money by investing the cash.
After all, there's no law that says you have to take a lump sum of cash from an inheritance, a bonus at work, an insurance/legal settlement, or even a lottery check and spend it on a three-week tour of the Orient or a new Harley Davidson (HOG) - Get Harley-Davidson, Inc. (HOG) Report Heritage Classic (OK - that is tempting).
By going the investment route, however, you're making passive income, i.e. money you've already earned accumulate and work for you.
What's the best way to invest lump sums of money in the financial markets? Here's a blueprint you won't like as much as a new motorcycle, but will treat you better in the long run.
How to Invest a Lump Sum of Money
The first step in making the correct call on investing your lump sum payment is to know what the term means.
A lump-sum payment is a payment that is made one time and one time only.
Unlike periodic or installments payments, a lump sum payment is the ultimate cash payment -- once the payment is made, that's it. No more money is forthcoming until you're fortunate enough to cash in on another lump sum payment, if that ever happens.
The most common forms of lump sum payments include the following scenarios:
You've Inherited Money
Receiving lump sum payments in the form of inheritance is among the most common form of lump-sum payments. Usually, estates prefer to take care of inheritance payments in a single shot, thus avoiding the paperwork and logistics of sending regular, annuity-like payments. While those forms of periodic payments do occur, a lump sum inheritance is much more common.
You Sell Your Business
Similar to inheritance payments, a single lump-sum payment after the sale of a business is usually the preferred way for buyers and sellers to handle the transaction. It's handled via a one-time check or electronic payment transaction between the buyer and seller's banks.
You Get a Bonus at Work
Depending on what you do for a living, a workplace bonus can be a modest or significant sum and it always comes in the form of a lump sum payment. Workplace bonuses are also usually a "once a year" affair and lead to the recipient's having to make a decision on how to best handle a lump sum payment.
You Get a Pension
Career professionals who earn a
can either opt to receive their money on an installment basis or as a lump sum payment. That decision depends on the beneficiary's own unique financial needs, but many retirees do elect to take their pension cash in a lump sum form.
You Get a Legal or Insurance Claim
If you're on the winning side in a court case or are in line for a big insurance policy payout, chances are you'll take the money in a lump sum payment. The same goes for winning a lottery, where many lucky ticket-holders opt to take their mega-lottery winnings in a huge, one-time payment.
The reason scash beneficiaries elect to take a lump-sum payment against an installment payment involve their own personal circumstances, or they're acting on a financial adviser or tax accountant's advice to better position themselves cash-wise, for any money owed to the IRS.
Making Your Lump Sum Investment
The best way to decide on how to invest your lump-sum payment -- and it can be more than one investment -- is to address your immediate financial needs first then work your way up from there.
While you should always discuss what to do with a lump sum payment with a trusted financial adviser, these five investment ideas could be a priority for you.
Pay Off Any Interest-Earning Debt
Yes, paying off debt actually is an investment in your financial future. In fact, paying down high interest-earning debt is a great investment as it frees you from onerous loan and credit payments over the long haul, which would otherwise eat into your household budget.
For example, if you use your lump sum to pay off $25,000 in outstanding student loan debt, at an interest rate of 5% and over a 120-month payoff period, you'd save $8,306.15 in interest if you just pay the entire debt off.
Plus, your credit rating will soar, too. Just make sure you pay off your highest interest-rate debts first -- you'll get more bang for your debt-reduction buck that way.
Invest the Bulk of Your Payment in a Company Retirement Plan
If your company
is slumping and yearly contributions have been meager, imagine the investment power of pouring $19,000 (the maximum yearly contribution limit in 2019) of a lump-sum payment into your retirement plan?
After all, the engine that makes investment grow is compound interest and the more money you put to work for you in a 401(k) plan, the faster and higher that money historically grows. Put another way, a big contribution to a 401(k) plan is also a tax-advantaged investment (you're not taxed on the cash until you retire and chances are, your company will match some of your contribution, dollar for dollar.)
That's a winning hand for any retirement plan investor with big plans in their post-working years.
Stash Cash in a Health Savings Account
Funding an HSA is a great way to protect yourself from the rising costs of health care, which annually rise higher than the rate of inflation.
is estimated to grow by 6.5% in 2020, according to SHRM.org and that's more than three times higher than the current U.S. inflation rate of 1.7% (as of September, 2019.)
HSAs have several distinct financial advantages.
They are tax-deductible and any cash you stash in a health savings account accumulates tax-free. As long as you spend your HSA fund money on qualified medical expenses, there is no tax on any withdrawals you make from your HSA fund.
If you run into substantial health care costs due to illness or injury, an amply funded health savings account can be a game-changer in protecting household financial assets.
Invest in an Emergency Fund
No, an emergency fund isn't as glamorous as a trip to Paris or stylish as a fully-loaded Land Rover, but when the chips are down and you don't have much cash in the till, an emergency fund can turn financial disaster into an easily managed household cash scenario.
By popping six months of home and life expenses into an emergency account (a bank savings account with a decent interest rate is a great place to start) you're building the financial savings you need to withstand a major personal financial calamity, like being laid off, being seriously ill or injured, or losing a small business.
Without an emergency fund, your home, your vehicle, your health insurance, among others, are put at substantial financial risk.
Invest in a Mutual Fund or Exchange-Traded Fund (ETF)
Investing in funds, especially equity-based
that historically appreciate in value over the long haul, is easier than investing in individual stocks. Funds are a no-hassle way to gain access to the greatest companies in the world and invest in their growth.
Think of it this way. In 1950, the Dow Jones Industrial Average was trading at just short of the 200 points. Today it trades at over 27,700 points. That's an amazing growth rate and ownership in it has some decidedly long-term financial advantages for fund investors.
The Takeaway on Lump Sum Investing
Nobody owns a crystal ball -- at least one that works anyway -- and nobody can predict the future.
That's why it's a good idea to take the bulk of your lump sum cash payment and put it to work for you making your financial life healthier and your long-term financial prospects brighter.
No worries, there's still plenty of time left for that trip to Paris.