It’s the kind of problem everybody wants to have: You inherit a lump sum of money, hit the lottery, or win a judgment in a court case.
Suddenly, you’ve got this pile of cash in your life and it’s burning a hole in your pocket.
So what should you do with it?
3 ways to deal with an unexpected windfall
The reality is you’ve got to be really careful if you’re not used to having lump sums of money. Here are three different approaches to consider…
Dollar cost averaging: The drip investing approach
If you’re going to invest the money, personal financial expert Clark Howard recommends what’s called “dollar-cost averaging.” It’s also known as drip investing. The idea is you put little dribs and drabs of money into the market in a steady cadence over time.
“My goal is to have you automatically put in a set amount of money regularly to build the habit of saving and reduce your overall risk to market ups and downs,” Clark says.
So with the same dollars each month, you’re buying more shares when prices are low and fewer when they’re high.
Over time, putting money in by drip investing reduces the possibility of you panicking when market drops happen. Which they certainly will!
So this approach helps keep you steady as you go. And staying in the game makes you more money over the long haul.
Lump-sum investing: The ‘going all in’ approach
Recently, there’s been talk in the investing world about how dollar-cost averaging isn’t as efficient as it could be for investors seeking long-term gain.
What’s been proposed instead is lump-sum investing, which is taking all of the windfall and dumping it on the market in one giant move.
“[Drip investing] has done better only when the market then fell, and since markets rise more often than they fall, lump-sum investing is a better bet,” Financial Times columnist Tim Harford writes in an opinion piece.
However, The Financial Times does concede this point: So much of investing is behavioral. If dollar-cost averaging helps you ride out the ups and downs of market fluctuations, then it may still be good advice for most people. Even if it’s not technically the most efficient approach.
The 90/10 rule
There is yet a third answer to the question that’s been favored by Clark.
Let’s call this one the contrarian “90/10 rule” he advises people to follow if they ever come into an unexpected windfall.
“What I like you to do is take 10% of the money and spend it however you want. Have a blast,” the money expert says. “For the other 90%, you be as conservative as you can be — i.e. a savings account or CD — and leave it alone so it’s there for your future.”
This is particularly contrarian because who would ever think a money expert would advise you to blow money?!?
But when done in a controlled way, it can help you get the urge to splurge out of your system. So you can focus on what’s really important!
Thanks to improving economic conditions, you can get a handsome return on your money in an FDIC-insured savings account. And rates are likely only going higher from here.
We’re talking about accounts that are completely safe, won’t ever lose value and are immune from sudden market drops.
For example, one online bank is now paying 2.30% APY on its simple savings account. And that’s just one of the many offers out there in the marketplace!
The most important thing when you come into a large lump sum of money is to not blow it entirely!
Whether you accomplish that by dumping it all into investments at once, doing drip investing or just by taking some of it and having fun while keeping the lion’s share in “safe” vehicles like banks and CDs is up to you.