One reason clients seek out a financial planner is to figure out what to do with cash. The amounts can be very different: $10,000, $50,000, $400,000, $800,000 and into the millions. Regardless of the number, we take the same approach by asking three basic questions.
The answers to these questions build a rough draft of a spending plan. Dollar amounts or percentages can be changed in a final draft, presumably after time for reflection or research.
1 – Is there something to celebrate or commemorate?
A windfall of cash often comes after a big event. Whether a happy event (a bonus from employment, winning the lottery) or a sad event (death of a loved one, a divorce), the windfall may come with a mix of emotions. Too, some events represent great changes that call for time to adjust to the new circumstances.
2 – What do you need in the short term?
In the next 2-3 years, what might you need extra money for? For a retiree, this can be setting up a stockpile of retirement paychecks. After a divorce, there may be expenses in setting up a new household or buying a new car.
You may need to keep cash secure and liquid in instruments such as savings accounts, money markets, CDs, and government bonds. Factors to take into account are the current inflation rate, interest rate changes, and your current cash on hand.
Is there a tax liability from the windfall? If yes, a good strategy is to immediately set aside money for that tax bill.
3 – What do you need in the long term?
A windfall provides a chance to bolster retirement or education savings. The new investments can be incorporated into a broader investing plan that takes into account when the money is expected to be needed.
As an example, someone with a $50,000 inheritance might decide to focus on commemorating a loved one, taking a dream vacation and saving for future education costs. This forms the basis for a rough draft of what to do with the windfall. After research and reflection, the amounts may change.
Rough draft for $50,000 windfall
5% for immediate fun spending
20% for dream vacation (requires research)
65% for house renovation (requires research)
10% for saving for education
Actual spending for $50,000 windfall
5% or $2,500 for donation to loved one’s favorite charity
5% or $2,500 for a new computer
50% or $25,000 for trip to Antarctica
20% or $10,000 for new kitchen appliances
20% or $10,000 for saving for education
For the person in this example, research into travel costs was important and guided more decision-making. Of course, another person’s priorities could result in a very different plan.
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