I’ll be the first to admit, the situation laid out in the title to this blog entry is far from the worst or most troublesome problem that you will face in your life. For most of us, getting a substantial amount of money in one lump sum is definitely a good thing, be it from tax refund, lottery winning, work bonus, or a positive legal ruling. (And in case you’re wondering what inspired this particular post, yes, I had a positive ruling in my court case. So I’m pretty happy, and have been considering what to do with some extra incoming money.)
Now, it’s hard to give hard and fast rules for what to do that work for everyone; there’s so many different types of lump sums, lump sum amounts and financial situations that it’s impossible to give a one-size-fits-all answer. The actions a nearly destitute person with tens of thousands in debt who happens to win the lottery should take are far different than those of a well-off person who happens to get a nice sales bonus at the end of year. While these rules are aimed more towards the moderate sized lump sum amounts, they should provide you with some starting points should you find yourself with millions in winnings. (Go you, if you do!) With that, let’s get to
6 Steps for Handling a Substantial Lump Sum
1. Don’t Start Spending Wildly: Regardless of the amount you’ve received or the reason you’ve received it, one of the best things you can do to ensure that you make the best of your new-found money is not to start spending it as soon as you get it (or worse, before you even get it). There are few things worse than ending up as one of the lottery winners who lost it all, and even if your lump sum isn’t lottery prize huge, you still don’t want it to disappear before you can plan out your next steps.
2. Figure Out Your Financial Goals: Chances are that you already have some idea of what you wanted to do with the next ten thousand dollars that came into your pocket (or perhaps even more; hey, let’s be optimistic!), even if you didn’t expect it to arrive so soon. But if you haven’t, it’s good to come up with some plans before you break out your pocketbook. You’ll be much happier (and better off, financially) if you put (most of) your new found cash towards some important financial goals, rather than just spending it. While it doesn’t have to be exactly what I’m about to recommend, these following steps represent a pretty good, if broad, idea of where to go with your funds:
3. Build Up An Emergency Fund: Having cash available for when life throws you a curveball is always important, and making sure you have at least some money in a safe, sound, easily-accessible place is vital. How much you can fund with one lump sum is variable, but until you have at least 3 months worth of spending money set aside, I wouldn’t worry about too much else. (You should be sure to set aside even more if you are likely to lose some of your income in the near-ish future.)
4. Paying Down Debts: If ever there was a goal every personal finance writer could get behind, it’d be this. Even if you aren’t getting enough money to completely pay off your debts, every debt you pay off (or simply reduce) means that much less in monthly payments in the future and that much more money each month that you can put towards other goals. As soon as you have a good emergency fund available, the next goal I’d suggest for your cash, whether from a lump sum payment or not, is to try to eliminate as much debt as possible.
5. Invest, Invest, Invest: With an emergency fund built up and your debts paid down, your next financial goal should be to grow your money. Hopefully, you’ve had the chance to put some money towards investments already, but a nice lump sum added to the pot can’t hurt. Depending on just how big this lump sum is compared to your normal investments, you might want to spread it out over the course of several months (although that is a disputed idea, and does raise its own problems), but putting that money towards money-building investments is always good.
6. Remember To Have Some Fun: Alright, we’ve spent most of this article covering what you should be doing with your money, but it’s worth remembering what you want to do. Having at least some of your lump sum set aside as ‘fun money’ will make the task of doing everything described above all the more enjoyable. As for how much money to put in the ‘having fun’ piggy bank, I’d say not more than 10% of your overall lump sum, since that leaves you with plenty more for all the other tasks while still being enough (hopefully, with a reasonable lump sum) to allow you to have some fun.
A Final Side Note: Remember that this is talking about small to moderate lump sums, typically no more than you would earn in one or two years at the very highest. If the lump sum in question happens to be lottery-size huge, you probably should look into specific methods of handling lottery-sized sums, starting with getting people to help you with the task. While that’s certainly a desirable problem to have, it’s a bit above my pay-grade, so to speak. (All of that said, I’d still recommend paying off all your debts as one of the first things to do; it’s hard to find better uses of money than to make yourself debt-free.)