Suddenly receiving a large windfall of cash—whether planned for or unexpected—is typically a great feeling. But that joy can often be partnered with stress about how to best manage the sudden influx so that it best supports your overall financial goals and investment strategy.
Invested wisely, that cash can turn into rocket fuel for your financial goals. But if it’s mismanaged, you could end up at a deficit trying to make up for poor tax planning or spending habits after the fact.
Regardless of how you came into the sudden cash, working with a professional to help decide how to handle preserving and growing it are key to avoiding costly mistakes. The most common sources I’ve helped clients navigate are:
- Inherited money from a loved one’s estate
- Earning a hefty bonus, whether from deferred compensation or some type of equity compensation
- Making a large sale of personal assets like real estate or a company
In this article, we’ll walk through three investment strategies we often suggest to clients when they have moments of sudden wealth.
(For the sake of brevity, we’ll refer to the cash as an inheritance throughout this article, but keep in mind that these strategies can be used regardless of what caused the sudden influx.)
Before we dive in, it’s important to know that these strategies are geared toward investing the extra cash and allowing it to grow.
Depending on your financial situation, you may have high priority short-term needs for the cash, like day-to-day living expenses, paying off high-interest debt (credit cards, personal loans, student loans, etc.) or establishing a healthy emergency fund.
We’d recommend you take care of those items first but if you find yourself with surplus afterward, you can consider the following investment strategies as options for the remaining cash.
All of these options will help boost your overall financial goals like fueling retirement plans and being able to leave a legacy.
Invest the Entire Amount as a Lump Sum
If you’re happy with your current investment asset allocation, you can invest the excess cash as a lump sum in your existing brokerage account or retirement accounts such as your IRA. We recommend a lump sum option as it historically has made more sense than the other options we’ll outline below.
But it can be a nerve-wracking strategy depending on the size of the lump sum. (It's a bit of an “all the eggs in one basket” approach, so if that doesn’t appeal to you, pursuing an alternative option is okay.)
If the market happens to drastically decrease after these trades are made, your advisor can balance your tax implications by taking advantage of the losses through a strategy called tax loss harvesting.
If the market drastically increases, there aren’t tax advantages, but the peace of mind you may feel mentally is often more important than monetary value.
Dollar Cost Average (DCA) Option
Another option for investing a large sum of cash is by splitting the amount up and investing it in smaller sums over time. This strategy tends to be a bit easier to swallow mentally and emotionally. Here’s an example of how it would work:
The total lump sum you’ve received is $2,400,000. You can split the amount up into six equal amounts ($400,000 each) and invest each amount monthly for the next six months.
In the meantime, you can retain the remaining cash and continue to earn interest on the balance in a high-yield savings account until it is invested, i.e.:
- On September 1, $400,000 is invested and $2,000,000 remains in cash.
- On October 1, the next $400,000 is invested, for a total of $800,000 invested, and $1,600,000 in cash.
- This pattern continues until all six installments and the associated growth in the high-yield account have been invested.
While the DCA option doesn’t make more sense statistically than a lump sum investment, some clients find it makes more sense on a mental and emotional level.
Combination Option
You can always take a combination approach as well, where you split the total balance between a lump sum investment and a DCA option.
For example, you invest 50% of the total amount as a lump sum now, and use a DCA strategy for the remaining amount. This will give you the option to hold some of the excess cash.
Alternate Savings Options
You may be surprised to see that simple high-yield savings accounts or certificates of deposits aren’t among our top recommendations.
Put simply, this is because even in a higher interest rate environment, the evidence-based investing philosophy we follow at Plancorp shows that cash can grow better over time within a balanced portfolio than at a typical bank.
As with everything, there may be unique situations where all or a portion should be placed in one of these options.
For example, if you need a place to hold cash temporarily or you will need access to the cash in a relatively short time horizon (think within 2 years), but generally we find that for our clients, the best solution is one of the investment portfolio integration strategies outlined above.
Do I Need a Separate Account?
Another common question we hear from clients when large influxes of cash come is where should the money go?
Should it be deposited into an existing taxable investment account or money market account? Is there a benefit to opening a separate account at your financial institution for just that cash?
There are pros and cons to a separate account, which we’ll outline below, but the short answer is: it depends.
It depends on your goals with the cash and your strategy for either spending it or investing it. Your financial advisor or wealth manager can talk through a plan with you and make the best recommendation.
Pros and Cons of Opening a Separate Account for an Inheritance
The following list of pros and cons assumes the beneficiary is married and inheriting the assets outright rather than into an irrevocable trust or as an inherited IRA (that’s a whole different can of worms that you can read more about here).
If these circumstances don’t apply to your situation, or there are other family members’ wishes to account for in the decision-making process, these pros and cons may still be relevant but we’d recommend consulting with an advisor.
Pros of a Separate Account
- Opening an individual taxable investment account in your own name where you will deposit the inheritance and make any withdrawals from assures that the assets are kept in your own name, rather than being co-mingled with a spouse. Depending on what state you reside in, an argument could be made that assets not in an individual account are marital property, which could cause a problem if you experience divorce.
- A separate account can help you earmark the funds for a specific goal or purchase. Setting the money in a separate “bucket” can mentally help so you don’t feel like you are going into your personal funds when you make withdrawals for this specific spending.
- If you want to leave the inherited assets to a specific person(s) or organization(s)/charity, it’s much easier to do so with funds in a different account with a designated Transfer on Death.
Cons of a Separate Account
- Placing the inheritance in a separate account gives you one more account to keep track of
- Utilizing a separate account could cause friction with your spouse. If you think this may be the case, work together on a plan that can be agreed upon. The ability to have healthy money conversations is so important in marriage!
- If adding a Transfer on Death designation is overlooked in your estate planning process (which a financial planner like Plancorp would make sure was in place), the account could end up in probate upon your passing, leading to unwanted estate tax implications.
- If the inherited assets end up co-mingling with your personal assets, it defeats the purpose of a separate account.
Final Thoughts
Regardless of how you came upon a large influx of cash, developing a strategy to manage it in the best way to meet your goals is key.
If the money is coming in as a large inheritance after the passing of a loved one, it is likely an already emotional time, so adding the stress of big financial decisions on top of that can lead to hasty decision making.
Our best recommendation is to have a plan in mind if you know the money is coming someday, and if it’s a surprise (hello, unexpected holiday bonus!), consult with your wealth manager or financial advisor to make sure you stay on track with your long-term goals.
Tax Implications
We'd be remiss to not mention that of course there are tax implications that go along with the amount and source of your windfall.
From supplemental wages tax to "inheritance tax" these all depend on your current income and where you decide to invest or spend. We'd love to help unpack exactly how it will impact your plan on a discovery call.
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