We don’t always have a plan for a lump sum of money that suddenly falls in our hands. The sum can range from a few thousands to a few million if you’re lucky. No matter what the amount is, the first thing to do is to sleep on your decision for a week at least before starting to think of your next step. Let the euphoria die down and avoid making any hasty decisions.
If your lump sum is considerable, you will be attracting all sorts of advisors and friends, keep in mind that the decision you have to take should put your best interest first not the government’s or the bank’s interest. Since everyone has a unique financial situation I will give you leads that will help you start your decision making process.
The grid below takes into consideration your risk tolerance but not your timeframe. You know better if you will need the money in the near future or in the long term. You are also to consider the advantages of using an RRSP (Registered Retirement Savings Plan), a TFSA (Tax Free Savings Account) for your investment or any other government program with tax benefits.
Depending on the amount of money you received, you might look to distribute it into several investment vehicles or pick only the one that fits your financial situation based on your risk level and timeline.
|No Risk||Low Risk||Medium Risk||High Risk|
|Start by paying off high interest debt such as your Credit Cards. Paying off a credit card is a perfect example of getting the highest return on your money for no risk at all, 19.5% in most cases!||High interest Savings Account. This could be your new emergency fund if you don’t have one.Money Market Funds: A fund that invests in short-term, low-risk investments such as treasury bills, bonds and bankers acceptances.||Utility trusts: These trusts invest in power, pipeline, and telecommunications companies. They tend to provide stable distributions and are considered defensive sectors.||Equity investments, the more you have (% wise) the higher the risk.|
|Pay off any outstanding amounts on your line of Credit or any other outstanding loans (your student loans for example).||Canada Savings Bonds: you lend money to the government for a set period of time at a fixed interest rate.Guaranteed Investment Certificates: you get paid a fixed rate of interest for a set period of time. Watch out for early redemption penalties!||You can also invest in REIT s: Real Estate Income Trusts invest in income-producing properties such as shopping centers, office buildings, and apartment buildings. REITs will produce consistent income monthly.||Investing in any venture you do not understand.|
|Make a lump sum mortgage payment, your rate of return will be your interest rate + the taxes you save on the interest you would have paid over the remaining period of years.||Annuities: A contract you buy from an insurance company paying you a fixed income, monthly.||If you don’t own your house how about you use it as a down payment?Buying your own property forces you to save and builds your net worth.||Foreign exchange trading. Speculating in currencies is the riskiest since leverage of 100:1 or more is easily accessible by the trader and the odds are clearly against you since only a small % of traders end up making any profits.|
Even though the capital is guaranteed in the low risk category there is always a chance you might end up with a negative return on your investment if the inflation exceeds your interest rate. Interest rates right now are very low which makes this scenario plausible.
Timeline, if you think you may need your cash quickly, do not consider locking your money in investments with a set date. Avoid paying early withdrawal penalties by identifying beforehand the proper term of your investment.
Fees, this is the most important variable to watch out for. You need to make sure you are aware of any management fees, commissions or monthly account fees. Fees can sometimes make the difference between a positive and a negative return on investment in the end.
Taxes, try not to excite the government too much. We are taxed enough as it stands. Go over your investment options taking tax efficiency into consideration. The more taxes you can avoid the better.
The categories above provide you with a good lead to start your decision process; make sure you discuss your options with an experienced financial planner before taking a decision. He will be able to properly advise you by taking into account all the factors that I mentioned above and more.
For further reading please refer to the following posts about:
Dear Reader, what are other factors that should be considered?