How to Invest a Lump Sum

Best Ways to Maximize a Lump Sum Distribution From a 401(k) or Other Source

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Whether you want to invest a lump sum from a 401(k) or IRA rollover, a tax refund, or an inheritance, or to invest lottery winnings, there are a few smart ways to best manage a large amount of cash, no matter what the stock market or economy is doing at the time. Here's what to do before and after you receive your lump sum.

What to Do Before You Receive Your Lump Sum

Depending on how much money you are due to receive, and assuming you have a little time before you receive your cash or check, you should begin looking for a place to hold your money. Research savings vehicles or security types carefully to invest your cash. Don't rush the decision.

You may have more than one use for your cash windfall. For example, you may want to pay off debt with a portion, give some away, use some for a well-deserved vacation, and use the remainder to invest for retirement. Any amount you do not use within a few weeks time can begin earning interest.

In most cases, you will invest in a money market fund for short-term cash needs. Money market funds are interest-earning savings vehicles that are liquid, which means you can generally deposit and withdraw from them at any time without penalty or fees.

Investors can typically buy money market funds at mutual fund firms, brokerage firms, and banks. Vanguard Prime Money Market (VMMXX) and Fidelity Cash Reserves (FDRXX) often have among the highest yields for the larger, well-known financial institutions.

Decide Whether to Invest Yourself or to Get an Adviser

Unless you have experience with investing, you may want to speak with a financial adviser before you decide what to do with your cash. Unless the money is burning a hole in your pocket (that is, you're afraid you'll spend it unless you find a place for it quick), you should take the time to find the best type of investment adviser ​for you. In most cases, a fee-only adviser with a Certified Financial Planner (CFP) designation is a wise choice, because stockbrokers, bankers, and insurance companies usually work for commissions.

When they're getting paid to sell you a particular investment over another, they may not be working entirely in your best interest.

Decide What You Want the Money to Do for You

This may sound too obvious, but you need to have a vision or structure for your money, or what will eventually be your investment portfolio, before you invest it beyond the money market fund. Similarly, you don't want to leave your cash in a liquid savings vehicle like that for too long, or you may be missing an opportunity to make your money work harder in something more appropriate for the task at hand. A financial planner would call this vision or structure your investment objective.

Lump-Sum Invest vs. DCA: Jump in Now or Slowly Invest Over Time?

Whether you put all your cash to work immediately or periodically invest portions with dollar-cost averaging (DCA), you need to make your decision completely upon your investment objective and risk tolerance, not what is happening in the stock market or economy at the given moment.

For example, if your time horizon is 20 years, you can invest the entire lump sum of money into your chosen investments all at once, because the total return over that long of a period of time will not change much by timing this far in advance. Also, there is more risk of decreasing your average returns by leaving too much of your cash in a money market account, as opposed to investing it immediately.

People who may want to dollar cost average into their investments include those who have low risk ​tolerance ​or those investors whose time horizons are not clear. For example, a person in his 60s who is saving for retirement may still have a 20-year time horizon. However, they do not know with certainty how long they will live. Therefore, this person may want to dollar cost average their lump sum into their investments over a period of time, such as one to two years. This way, if there is a dramatic decline in stock prices, the investor can minimize losses and maximize future returns by investing a specified amount, once per month, over several months or a few years.

To summarize, the primary deciding factors in figuring how to invest your windfall will be your investment objectives, risk tolerance, and what you want the money to do for you in the short run and in the long term.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.