Summary
- Consider what you need to do before you invest a large sum of money, such as paying off debt, creating an emergency fund, and considering taxes.
- Consider your own time horizon and risk tolerance when choosing investments.
- Taxes are a big factor – bigger than you might expect. Consult with a professional for the most tax-efficient investing strategies.
- Unbiased can connect you to a financial advisor to answer any questions you have about investing.
What counts as a large sum of money?
What counts as a large sum of money? You may find yourself with a windfall from one of these common situations:
- Inheritance
- Life insurance payout
- Large investment gains
- Selling assets
- Legal settlements
- Unexpected tax refunds
- Lottery winners
- Year-end bonus
A large sum may need a different approach than regular monthly investing. When you come into a large sum all at once, you’ll need to diversify investments, consider taxes, and get your financial plan in order in short order. It’s complex, and some professional advice can help.
Steps to take before you invest a large sum
Before you invest, you may have a few things to consider. Some of these may include:
- Pay off high-interest debt: Paying off high-interest debt makes sense. The interest you’re paying is a significant drain on your resources, and putting it aside will strengthen your financial position.
- Put aside an emergency fund: If you don’t yet have a fully funded emergency fund, consider setting aside some money here first. Emergencies happen, and having the funds to cover them will help.
- Make a financial plan: If you haven’t met with a financial planner yet, you may want to do so. A financial plan helps ensure you’re putting away enough money in the right places so you can reach your financial goals.
- Consider taxes: You may need to consider taxes before investing to ensure you don’t receive a large tax bill when you no longer have the money to cover it.
Lump-sum investing vs. dollar-cost averaging
The two main approaches to investing a large sum of money include a lump-sum investment and dollar-cost averaging. Here’s how they work.
How lump-sum investing works
Lump-sum investing is where you invest your money all at once. You can benefit from any immediate positive market moves, but you could also experience the negative side of market volatility by investing all at once.
How dollar-cost averaging works
Dollar-cost averaging is where you invest the same amount at regular intervals. With this method, you invest whether prices are high or low, creating an average over time for what your cost is to invest.
Which strategy tends to perform better
Lump sum investing has historically delivered better results than dollar-cost averaging more than 68% of the time, according to Vanguard. But if you’re worried about market volatility when you’re ready to invest, dollar-cost averaging could give you peace of mind. Risk tolerance still matters more than numbers for many investors.
Where to invest a large sum of money
Where should you invest your money? There are many options. Some of the main ones include:
Stock market investments
Index funds, ETFs, and individual stocks offer great possibilities for long-term growth. Most portfolios have a significant exposure to stock market investments.
Bonds and fixed-income investments
Bonds and fixed-income investments can reduce portfolio volatility and generate income. They’re typically lower yield, so they’re better for a smaller portion of your portfolio.
High-yield savings accounts and CDs
High-yield savings accounts and CDs are low-risk places to put your money when you’re looking to preserve principal. Many high-yield savings accounts offer competitive returns.
Retirement accounts
Investing via a retirement account produces tax advantages. Traditional retirement accounts such as 401(k)s and traditional IRAs reduce your taxable income now. Roth accounts are taxed in the current tax year, but any qualified withdrawals made in retirement are tax-free. HSAs are triple tax-advantaged, reducing your tax liability now, offering growth-free taxes, and tax-free withdrawals in retirement.
Taxable brokerage accounts
Taxable brokerage accounts have no ceiling and offer flexibility that a retirement account can’t. You will need to watch your taxes, and a tax accountant or financial advisor can help with tax-efficient strategies.
Real estate
You could invest in real estate via rental properties, REITs, or real estate crowdfunding. Real estate investments provide real assets, diversification, income, and potential appreciation.
Alternative investments
Alternative investments include private equity and venture capital, hedge funds and private credit, commodities, farmland, collectibles, art, cryptocurrencies, and more. Alternative investments aren’t appropriate for everyone, and not all investors are qualified. Consider the risks relative to potential rewards.
How to manage risk when investing a lump sum
When you’re investing a lump sum, you’ll want to consider risk and how to manage it. Here’s what you need to be aware of.
Diversification: Diversification creates balance in your investment portfolio to weather different market conditions. Invest in different asset classes across different sectors.
Match the investment horizon to goals: If you have a long road in front of you, you may be able to take on more risk and weather the ups and downs of the market. If you’re closer to retirement, you may want to invest more conservatively.
Avoid concentration in a single asset: It’s tempting to invest all your money in a single investment once you find one you believe in. With this type of concentration, your investments are more exposed to market swings and your portfolio sits in a riskier position.
The bottom line
Investing a lump sum comes with some unique challenges, but you don’t have to make all these decisions alone. A financial advisor can offer significant help.
If you’re looking to hire a financial advisor, Unbiased can easily connect you to one. A few questions can