This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
If you come across a lump sum (perhaps from a business sale or an inheritance windfall), what is the best way to invest it? Should you invest it all at once or gradually? Is it best to simply hold most of it in cash? In this article, our financial planners in Padiham offer three key principles to consider when deciding how to invest a lump sum. We hope this content is useful to you and please get in touch if you’d like to discuss your own financial plan with us over a free, no-commitment consultation.
#1 Evaluate your financial plan
A lump sum could certainly provide a nice boost to an investment portfolio (e.g. a retirement fund). Yet are there any weaknesses in your financial plan which could be addressed, first? A good starting point is your emergency fund. This helps prevent you from turning to credit when large, unexpected costs befall you (e.g. an expensive home repair, like a broken boiler). Having 3-6 months’ worth of easy-access savings for this purpose is a good starting point. If you hold any costly debts weighing down on your finances such as personal loans and credit cards, moreover, then a lump sum will likely be better used to address these over building a portfolio. This is because the interest saved on the debt will probably be higher than the returns you can realistically hope to achieve from investing.
#2 Decide on your goals
Assuming at least some of the money is to be used for investing, what exactly do you want to achieve with it? Your goals will have a crucial impact on which assets are appropriate for your portfolio. For instance, saving for a mortgage deposit in the next 3-5 years may lead an investor to take a more “cautious” approach with their asset allocation (since there is little time for the portfolio to recover if a market crash occurs in the investment timeframe). However, an investor looking to build a retirement fund over the next 30-40 years can afford to take more risk with their investments (assuming they are comfortable with this). Here, there is far more time for a portfolio to “ride out” market falls and surpass them by riding a long-term growth trend.
Another goal to consider is growth versus income. The aforementioned investor, for instance, will likely be concentrated on the former, since a growth-oriented goal is primarily concerned with value appreciation (e.g. finding companies which re-invest their profits into growing the size and value of the business, hopefully also increasing the share price). An income investor, however, is likely more focused on using their investments to support their lifestyle. A person entering retirement, for example, may fall into this category (the “deculumation” phase) and they seek to preserve the wealth they have built up over the years and use it to provide a regular income – e.g. through dividends and interest payments from bonds.
#3 Consider how to commit your investment
With your goals clear, how quickly should you commit the money to your chosen portfolio strategy? One option is to simply commit everything at once (as a single lump sum). Here, the potential upside is that lump sum investing has the potential to beat “pound cost averaging” (adding the money slowly to your portfolio) by 75%. However, the risk is that your portfolio may be disproportionately damaged in the short term if the market crashes shortly after making your lump sum investment. This matter relates to your risk tolerance; i.e. how likely you are, in practical terms, to take your money out of the market if this happens. If you and your financial adviser agree that you could cope with staying invested during this volatility, then committing a lump sum may be an appropriate option. However, if you know you will face a strong temptation to pull out into cash (thus potentially crystallising large losses) then it may be better to consider another approach.
The main alternative is to “drip feed” your money into your portfolio, known as “pound cost averaging” (e.g. over 12-24 months). The advantage of this approach is that it limits the impact of a potential market crash on your investments. If this transpires, then during the months that the market is down, this can allow investors to buy assets “on the cheap” before a (hoped-for) market recovery. This can help preserve the value of a portfolio if the market is volatile, and is thus often easier for investors to stomach compared to investing a lump sum. However, if your long-term goal is wealth growth, then consider (with your adviser) about how your investments may perform compared to investing a lump sum. There is also the opportunity cost to consider when holding some of the money in cash (as it waits to be invested). Whilst this money is sitting in cash, it is potentially not earning the returns it could be making from being invested. It may also be eroded disproportionately during periods of high inflation.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
