Personal Insights

Money management: What to do with a lump sum

Here are six steps to take if you’re managing sudden money.

Key takeaways

• Give yourself time before making major financial decisions so you can evaluate how a lump sum fits into your long-term goals.
• Strengthening your emergency savings, reducing high-interest debt and maximizing retirement contributions can help improve your financial foundation.
• A thoughtful investment and financial planning strategy can help a lump sum grow and support future financial goals.

Let’s start with an extremely pleasant hypothetical: You just received $25,000. The source of the cash doesn’t matter. It could be an inheritance, a gift or a bonus you receive as part of your job.

Your first instinct may be to spend it all on a big-ticket item like a new car. While this sounds good, a car can be a depreciating asset and that purchase may not be a particularly wise move when an alternative can include making smart investment choices to put yourself on the path to financial well-being. It’s also important to take the time to discuss the tax implications of this lump sum with a tax professional.

Before making any major financial decisions, consider giving yourself time to evaluate your options. Whether your lump sum comes from an inheritance, bonus, severance package, business sale or insurance settlement, a thoughtful plan can help you make the most of the opportunity.

With the goal of financial well-being in mind, here are a few tips to help translate a lump sum of money into an appreciating asset that can increase in value over time.

Step one: Give yourself a small treat

Your goal is to invest the vast majority of your newfound wealth such that it will provide lifelong benefits. But for some of us, the notion of responsibly setting every penny aside is too much to bear. For that reason, it’s OK to make a small purchase, just to get it out of your system.

“The idea is to alleviate that impulse to spend all the money,” says Patrick Rehm, a Financial Advisor with Regions Investment Solutions. “Take a chunk and improve your house, or take a vacation and then you can get serious about what you need to do.”

Consider setting aside a modest portion of the windfall for something enjoyable. Giving yourself permission to enjoy part of the money may make it easier to remain disciplined with the rest.

Step two: Strengthen your emergency fund

Before investing additional money, consider whether your emergency savings are sufficient. Many financial professionals recommend maintaining three to six months of essential expenses in an emergency fund, though your needs may vary based on your income, family situation and overall financial picture.

Step three: Increase retirement contributions

Now that there’s extra money in your checking account, consider how these funds fit into your broader financial plan. Use the money to take maximum advantage of perks such as employer-matching funds to your retirement account and make the maximum allowable contributions to tax-friendly investment vehicles such as IRAs, 401(k)s and health savings accounts. Contribution limits and eligibility requirements can change over time, so it’s important to review current rules or discuss the move with a financial professional. “These are top-priority investments that can pay big dividends down the road,” Rehm says.

Step four: Pay down high-interest debt

If you carry balances on credit cards or other high-interest loans, using a portion of the lump sum to reduce or eliminate that debt may improve your financial position. Paying off debt can provide a guaranteed savings on future interest costs and may free up cash flow for other goals.

Step five: Invest your money

Investing in financial markets can be one way to put your money to work, but it’s important to do so in a way that is consistent with your risk tolerance. Work with a financial advisor to determine your tolerance for risk and develop an investment strategy. “Be patient and diversified,” Rehm says. “Investors with a longer time horizon may be better positioned to withstand short-term market fluctuations.” Investments can be spread across sectors and asset classes to help mitigate market swings and risk.

Whether it makes more sense to invest your money or pay down debt depends on several factors, including interest rates, risk tolerance and financial goals. For some households, paying down higher-interest debt may offer a meaningful benefit. For others, investing may provide greater long-term growth potential.

Step six: Make a financial plan

You’re not obligated to leave the money alone forever. Pick some point at which you want to access the funds and work with a financial advisor to craft a strategy that optimizes the likelihood that your desired amount of money will be there for you when you need it.

By then, if you’ve followed steps above, the sum at your disposal has the potential to be greater than the original investment amount.

When you find yourself with an unexpected lump sum of money, it’s tempting to forget everything you learned about financial responsibility over the years. It’s fine to treat yourself, but crafting a careful financial plan of action can help grow your investment and keep money there for you in the long term.

Just as importantly, a lump sum can provide an opportunity to strengthen your overall financial foundation by building emergency savings, reducing high-interest debt, maximizing tax-advantaged accounts and investing toward future goals. Taking a measured approach can help you put the money to work in a way that supports both your immediate needs and your long-term financial well-being.

Looking for professional guidance?

Find an advisor in your area or get started on your journey via our wealth management guide.