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Investing a Lump Sum for Retirement - What to Do and Pitfalls to Avoid

Receiving a lump sum of money can be a life-changing event. Whether from selling your home for a profit, cashing out a major equity investment, or collecting an inheritance, it’s a substantial boost to your wealth. Used wisely, the money can have a huge impact on your retirement plans.

Investing a lump sum is a bit different than allocating standard contributions to your IRA or 401(k). Similar principles apply - you want a balanced portfolio that fits your stage in life - but getting a big chunk of money all at once can affect your goals and overall investing strategy. So how can you best use a lump sum to enhance your retirement plans?

What to Consider Before Investing

Deciding what to do with a lump sum might seem daunting. You want to make the best use of it, but there are an endless number of ways you can invest. As with most financial decisions, it’s important to see how options fit into your long-term financial plans.

There are a few key factors to consider when determining how to invest your new windfall:

  • How old are you?
  • Are you already retired? If not, how many more years do you plan to work?
  • What is your vision for retirement?
  • What other assets do you have and how are they allocated?
  • Will you need the funds to pay monthly expenses?
  • Do you have any debt or loans to pay off?

If you have any questions or doubts as you navigate the process, a financial advisor can be a huge asset. Just make sure you’re working with a fiduciary rather than a commission-based broker. Fiduciaries must act in their clients’ best interest, so you can be confident that the advice you’re receiving is objective.

Three Common Mistakes to Avoid After Receiving a Lump Sum

It’s easy to make rash decisions when dealing with a sudden windfall. Most of us only face the situation a few times throughout our lives, so there’s an element of uncertainty (along with the joy of seeing your wealth grow). While sticking to your long-term financial plan is key, it’s just as important to avoid making painful mistakes that can derail your retirement.

Here are three of the most common mistakes that people make with lump sums:

  • Spending or Investing Immediately - There’s nothing wrong with splurging a bit, but lavish spending can add up and quickly put a dent in your newfound wealth. Rather than rapidly making big purchases or financial decisions, take some time to research and carefully weigh your options.
  • Making Big Life Changes - Depending on how big of a lump sum you get, it might be tempting to quit your job. Before you do, figure out how it affects your overall financial outlook and whether you’re actually ready to retire.
  • Withdrawing Funds from Inherited Accounts - In the case of an inheritance, it may seem logical to close those accounts and consolidate the funds. However, there are usually tax implications to large withdrawals from inherited retirement accounts. Make sure you work with a professional to understand the financial consequences before you take money out.

How to Choose Investments That Fit Your Needs

The biggest factor in choosing how to invest your lump sum is your timeline. If you’re already retired, you’ll want to stick to safer options that will still provide a steady return. Conversely, younger people can afford to take on more risk in exchange for more growth over the long haul.

Most investors will want their money allocated to a blend of different timelines. Rebalancing your portfolio is important as you age and your financial situation changes. But a sudden influx of money is also a good time to evaluate your investments. Let’s look at the different timelines for investing.

Long-Term Investing Options

On a longer timeline, your focus is generating growth, even if it carries some risk. You’ll want to allocate more of your portfolio to stocks. While downturns in the market will impact your portfolio, the long-term gains will more than likely cover temporary losses. For someone with ten years or more to let their investment grow, we generally suggest an allocation of 60% in equities and 40% fixed income (bonds, cash).  Of course, as with all investing, the specific allocations will depend on your entire financial picture, as well as your risk tolerance.

Medium-Term Investing Options

On a scale of five to ten years, the goal is to balance low risk with bigger growth potential than short-term options. You’re looking to outpace inflation and possibly grow your portfolio, but you also want a reasonable certainty that your principal is safe. Treasury notes - the medium-term equivalent of Treasury bonds - are a good option on this timeline. While Treasury notes are considered one of the safest investments, you may also want to have some growth potential.  At this point, we would recommend having no more than 25% of your investment portfolio in equities.

Short-Term Investing Options

A short-term investment plan is best for money that you plan to use in less than five years. You may have a small portion of your portfolio invested in equities - but for the most part, you should focus on protecting your investment. Savings and money market accounts are the most common options, as they keep your money safe and easily accessible. CDs and short-term government bonds are good choices for money you won’t need for a fixed period of time and want a slightly better return on.

Putting a Lump Sum to Work for You

Whatever stage of life you’re in, receiving a lump sum is a big boost to your retirement plans. For younger people, it represents an ability to invest more aggressively and possibly even retire sooner. For retirees, it can mean added comfort or funding more travel.

Like most financial decisions, it’s important to keep your overall retirement plans in mind when investing your newfound money. With the assistance of a trusted financial advisor, you can keep yourself on the path to a comfortable and secure retirement.

Want to find out more about how to use a lump sum to build a secure financial future? Download our 2021 Essential Retirement Guide to learn how to set up your perfect personal retirement plan.

Essential retirement guide 2021

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