By FPA member Lisa A.K. Kirchenbauer, CFP®, RLP®
Last Updated: January 18, 2010
The beginning of the year often brings windfalls that need to be managed. Whether it's last year's bonus, a tax refund, or a substantial gift check from the holidays, it's best to take a moment to plan your strategy for using that money. Below are some basic tips for successfully managing these kinds of windfalls:
- Enter a brief "decision-free zone." The Sudden Money® Institute recommends that one of the first steps you should take is to stop and not make any major decisions. Don't commit the money, don't spend it, take time to think about the best strategy for you.
- Assess your situation. Do you have high-interest rate debt, no emergency fund, a tax bill due in April?
- If you have an emergency fund, and aren't carrying debt, then you can begin to consider longer-term investments, such as, a vacation, or perhaps a home-related or personal purchase.
- If you are carrying high-interest debt (higher than 10 percent to 15 percent), consider paying down some of it with your windfall. By doing that, you are actually paying yourself at a rate equal to the interest on the debt. Do not pay it all off if that will leave you with no emergency fund.
- Build an emergency fund of at least three to six months' worth of expenses.
- Are your estate planning documents (i.e. will, powers of attorney, living will) in order? If not, consider "investing" some of the windfall in getting your financial house in order. Money invested is nice for your heirs, but not if you have not properly planned for your estate.
- If you still have money left, consider investing some or all of it long-term. Fill out the areas of your portfolio that may have lower allocations (often small company stocks and international) depending on your risk tolerance. Given the volatility of the stock market over the last two years, consider "dollar-cost-averaging" — making smaller periodic investments instead of a lump sum — it into the investments that you selected, perhaps over a two to three month period. If you are already heavy on stock investments, then consider balancing things out with some diversified, short to intermediate-term bond funds, and also consider funds that may provide some inflation protection through Treasury Inflation Protected Bonds (called TIPs).
Windfalls offer an opportunity to catch up, move ahead and reward yourself. With a little thoughtful planning, it can be a decision that you'll be proud of, and benefit from, for years to come.
FPA member Lisa A.K. Kirchenbauer, CFP®, RLP® is the president of Omega Wealth Management.