What to do with a windfall

What's the best use of money you have inherited, whether it’s from a deceased relative, lottery or gambling winnings, or some other source? Hamm writes that the first and best option is to pay off debt.

Perhaps three or four times a week, a reader will email me asking what they should do with a sudden windfall that they’ve inherited, whether it’s from a deceased relative, lottery or gambling winnings, or some other source.

Almost always, their goal is to keep the money safe for the short term while also earning some level of return on that money while it’s safe. It is very rare for a person asking this question to have a clear short-term goal – if they did, they wouldn’t be asking the question.

So, I assume that people asking this question have a long-term goal for this money, usually extending to the ten year mark or further out, if they have any goal at all.

What are the options with that perspective? 

The first (and best) option is to pay off debt. If you receive a windfall and have any outstanding personal debt, get rid of it.

From a purely “dollars and cents” perspective, debt reduction might not be the best option available to you if your interest rates are low. After all, if you can earn 7% long term in the stock market compared to a 4% debt, your money would grow better over the long term in the stock market.

However, paying off debt is secure. It guarantees you a return on your money equal to the percent interest on the debt for as long as you would have otherwise have the debt because you’re no longer paying that interest. It stays in your pocket where it belongs.

Even better, fewer debts mean fewer monthly bills, which means less lifestyle risk. The fewer monthly bills you have, the lower the impact of things like job loss, career changes, unexpected illnesses, and many other situations. If you have a big pile of monthly bills, you begin to walk a tightrope where things fall apart quickly if you slip. Paying off debt lowers that tightrope quite a bit.

What do you do, though, if you’re free from debt already? If that’s your situation, you should invest it for the long term.

The problem is that there are a ton of options available when it comes to long-term investing. You can keep it in savings. You could buy a CD. You could invest it in stocks. You could buy real estate. Those are just some of the options.

Each of those options has some benefits and drawbacks. Let’s look at the ones mentioned above.

If you want your money to be as secure and safe as possible, with virtually no risk of losing the balance of it, and you’re willing to accept a very small but steady return on your money for that, then a savings account is probably the best place for you. This is the option I would choose if I was very concerned about risk or if I had very limited income. Unless you can get a CD rate that’s more than a percent higher than what you can get in a savings account, I would never buy a CD.

If you are willing to accept some risk and you already have some additional income (and some spare time), real estate can be a solid option. You can either buy land to sit on it for the future, or you can buy properties to rent or lease to others. In the first case, you don’t need much money to maintain the land other than the cost of property taxes, but the investment on the whole will have some risk to it. In the latter case, you’ll need property tax money as well as funds to maintain the property (and you’ll need time as well to take care of that maintenance and other landlord issues), but you can earn a solid income.

If you are willing to accept some risk and want to invest with minimal effort and time investment, stocks are a good choice. The broader stock market is estimated to return an average of 7% a year over the very long term, though over individual years you can potentially earn much less (even a loss) or earn much more.

If you’re more interested in long-term returns that you might want to spend in a lump in the far future (ten years or more) and don’t care that much about earning regular income right now, I’d invest in a broad stock market index fund by opening an account at Vanguard and investing all the money in the Vanguard Total Stock Market Index, which essentially buys a slice of almost every publicly-traded American stock.

If you’re more focused on earning some regular income while the balance sits there and largely breaks even, I’d open an account at a brokerage (say, Scottrade) and split the money up among several steady dividend-paying stocks. I’d stick with big companies you’ve heard of that have a long history of paying dividends (these ten are a great place to start). Dividends are simply cash payments made to anyone who owns a share of a company’s stock. For every share you own when a company issues a dividend, you earn a small amount depending on the dividend size. If you buy a stable stock with a long dividend history, then it’s going to be fairly reliable income.

These are the options I would strongly consider in these various situations if I suddenly received a windfall. At this point in my life, I would probably invest in stocks, as I have no interest in the issues and time involved with being a landlord, I don’t have any debt, and I don’t mind some risk.

Good luck!