Who hasn’t dreamt of all the crazy things they’d buy if they were to win the lottery? Or stared out into the night sky, wondering if there is some great-aunt out there planning to leave behind a big, unexpected inheritance?
And in life, these things can happen. Windfalls can result from fortunate events, like lottery winning, and unfortunate events, like a legal settlement. No matter the triggering event, a big injection of cash can certainly be a life-changing event in someone’s life. And hopefully, this chunk of change is a positive force.
But even though most people aren’t complaining about getting a bunch of money, coming upon a financial windfall may also usher in feelings of anxiety, stress, and guilt. If you are feeling this way, know that this is not unusual and you aren’t alone.
Not to mention the temptation to blow the money, which is a real one that shouldn’t be discounted. We’re all human.
While it’s fine to spend some money on the fun stuff, it may help to curb that urge by making a plan for investing windfall money.
If you have found yourself with some extra money, here are some steps you can take and ideas to keep in mind as you determine the best way to put the money to work. Here are just a few options you might consider:
While prioritizing your financial health is a good hill to die on, it’s also important to treat yourself and enjoy your life. Depending on the size of your windfall and how caught up on financial goals you are, you may want to take yourself out for a delicious lunch, weekend trip, or buy the Roomba that you know will make your life easier.
It may help you to give yourself a set percentage that you’re allowed to spend on fun. For example, you could make an agreement with yourself: “I will spend 5% of the total amount of the windfall, but the rest will be allocated to achieving my financial goals.”
Not all big sums of money that come into your life will be taxed the same, so do some research to make sure you know what your tax burden will look like.
For example, a gift from a relative, an inheritance, or a life insurance payout are generally tax-free to the recipient . (Although an inherited IRA would be taxed as income if withdrawn from the account.) However, the estate or gift-giver may owe taxes.
Compare this to money won through gambling or the lottery, which is considered taxable income. Be prepared to pay income taxes on these winnings. Selling an investment, such as a home or stocks, may trigger what is called a capital gains tax. And then the sale of employee stock options has its own set of unique rules.
To be certain, you’ll likely want to check with a tax professional to understand both the federal and state tax implications of your financial windfall.
If you’re feeling overwhelmed by your new wealth, it’s also possible to hire help. There are professionals out there with expertise in navigating exactly your situation.
You may want to consider a tax advisor, an estate planner, or lawyer that can help provide you with legal advice and draft up legal documents like a will and trust.
If your questions are more general related to your overall financial situation, you can always work with a CERTIFIED FINANCIAL PLANNER™ professional. One unique member benefit at SoFi is complimentary access to credentialed financial planners to discuss your personal finances.
Prioritizing Your Goals
Coming upon a financial windfall could be an opportunity to evaluate or reevaluate your financial goals. What is important to you? What are your top money priorities?
Everyone’s money goals are going to be different. Personal finance is just that—personal. While there are certainly some financial guidelines on what to tackle and in what order, that doesn’t excuse a person from sitting down and doing the work of mapping out their goals.
For example, not everyone has the goal of buying a house. This is not to say that it is a good goal or a bad goal, but that home ownership is a personal decision that requires careful consideration.
Ask yourself questions like: “How would a mortgage fit into my current and long-term plan? How will buying (or not buying) a home impact my retirement? What would happen to my mortgage if I were to lose my job?”
Asking Yourself the Right Questions
When you come upon a large sum of extra money, a natural first question to ask is, “How should I invest this money?” But here’s the thing—there is no universal one right answer to this. How you invest the money—which asset classes you choose to invest within—will likely need to be dictated by many factors including what your goal is for that money.
How you invest the money will depend on what the money is earmarked for. For example, you would likely invest differently for retirement than you would for a shorter term goal such as a wedding that is a few years away or a down payment on a house that you will buy in 5 years.
If the money is for ongoing expenses such a medical bills it is not likely to be in one’s best interest to have the money invested, but a consideration could be a high yield savings account or something that has principal protection.
Ask yourself the following questions: “What is my goal with this money? When do I need the money? And last, how much risk am I comfortable taking with this money?” Once you’ve homed in on what it is that you would like to accomplish with the money, you can better match it to an appropriate investment strategy.
Knowing That Cash Is Risky Too
With a large windfall, it can certainly be enticing to hold onto that money for dear life. But, depending on your goal, burying the cash in the backyard may not be the best strategy. Cash may not be as safe of an investment as you think.
Cash for short-term goals, like an emergency fund that you may want to deploy at any time, or for a down payment on a home that you’ll buy in a year might make sense. But beyond that, holding cash may actually cause you to lose purchasing power over time. That’s due to inflation, which is the phenomenon of rising prices over time. As goods and services increase in value over time, the value of your cash decreases.
Sometimes, people feel like it is safest to hold cash. That way, they won’t lose anything. But with the forces of inflation, you are losing, but in a way that’s harder to feel in real-time. But that doesn’t mean that the effect of inflation isn’t real.
Considering Your Options
When making a decision about what to do with your money, it’s helpful to have a solid understanding of the options available to you.
Folks may want to begin by paying off their high-interest debt, like credit cards, and saving up for an emergency fund. If you have credit cards or don’t have a fully funded emergency fund, this can be a good start for investing your financial windfall.
Paying Off Credit Cards
Why? The average interest rate on a credit card is over 15% . It is very hard to invest in such a way to out-earn what you are paying in credit card interest. Therefore, if the goal is ultimately to build wealth, then the credit card balance likely needs to go.
Creating an Emergency Fund
A cash reserve can be helpful in the event that an unexpected expense comes up. This way, an emergency doesn’t get put onto a credit card, which will likely have the effect of making the already-emergency into an even more expensive problem.
While it is ultimately up to you to determine how much money to keep in an emergency fund, a good place to start might be at least three months worth of expenses.
Saving for retirement is a big job and most people are behind in doing so. Catching up on retirement savings can be an excellent use of unexpected money like an inheritance, lottery winnings, or a bonus at work.
Depending on your employment, income, and tax situation, you may look to add some or all of your windfall to a retirement account. Check with a tax advisor to see what options are available to you.
If the money does not qualify for a retirement account, it is still considered a good idea to invest that money for the long-term, it just won’t have the same tax benefits of doing so within an account that offers tax advantaged investment growth.
You may decide investing is the way to go. Most investors keep some sort of mix of stocks and bonds for their long-term money, and the proportional mix is called “asset allocation.”
It is generally recommended that younger people have a higher allocation towards stocks which normally have more upside potential than stocks , and that mix moves to more bonds over time which are considered more stable as you move towards retirement years. To fulfill these allocations, it is possible to invest directly in stocks and bonds or by using mutual funds or exchange-traded funds (ETFs).
If you would like help creating and maintaining an investment portfolio, services like SoFi Invest® could be a great choice. SoFi Automated Investing uses a portfolio of exchange-traded funds (ETFs) based on the investor’s goals, risk tolerance, and timeline. And best of all, there’s no additional charge for this service.
Paying Off Student Loans
As far as interest rates are concerned, student loans can run the gamut. It might be a good idea to check on the interest rates of your loans, whether federal or private, and decide if paying down loans is a good use of your extra cash.
In making the decision between paying down debt and investing, a good rule of thumb is to compare interest rates. For example, you may expect to earn 7% investing in the stock market, and you’re paying 10% interest on a private student loan. In this comparison, you may choose to pay off the debt to save on interest.
The difficult part of doing this analysis is that it is impossible to predict the future of investing returns, therefore it cannot be known with certainty whether paying off the debt or investing in the stock market is the better financial decision.
Therefore, this is a very personal decision, and after performing research, you may end up honoring what your gut is telling you. For example, if the debt is a dark cloud over you and it would improve your mental health to eliminate it, then it may feel right to do that.
On the contrary, if you feel like you are totally missing out by not investing and taking advantage of compound returns, then investing may be the way to go instead. And of course, this decision does not have to be all-or-nothing, it’s likely you can do some combination of both.
If your dream is to own a home, a financial windfall can certainly be used to make that dream a reality. For some people, it is a lovely idea to take extra money and to use it to buy a home that they love and feel the value of each and every day.
A financial windfall can be used to aid in buying a home in a few ways. First, it can be used as a down payment. And as a bonus, having more money to put down on a home means a lower loan amount which can help to lower the overall interest costs of the mortgage. Further, having a slush fund of extra money as you enter into home ownership is probably not a bad idea.
Also, unexpected costs can arise, and home maintenance can be expensive. The next time a toilet breaks or windows need sealing or property taxes are more than expected, you won’t regret having some easily accessible cash available for use.
One of the first steps into home ownership is finding a lender that you can trust. Buying a home shouldn’t be stressful—or take you out of your financial comfort zone.
Best of all, they’ve got a team of people that can help you navigate this big step and who want you to feel confident in the way that you’re spending your financial windfall.
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