This guest post is written by Silicon Valley Blogger, who runs The Digerati Life, a general personal finance blog. I’m really honored by SVB’s contribution. Her blog was a major inspiration for me when I started Pilgrim and it still is. I’m sure you’ll enjoy reading this as much as I did.
So what do you do when life throws you a bit of good fortune? Let’s say for instance you inherit a sizable amount from a close relative. How would that change your family financial planning? Well, naturally, your thoughts may turn to investing. Now this scene is oft-repeated across the nation, involving folks who have no clue about how to invest money and who, up to this point, have no real savings to speak of.
It’s the same song and dance for millions of Americans across the country. We go to work every day, pay our taxes, gripe about the economy and those damn politicians, raise our kids and live life one paycheck away from homelessness. So imagine receiving $50,000 all at once – wouldn’t it be overwhelming? It’s an opportunity for your mind to race around all the things you need, want and simply thought would be cool; and for a few of us, we’d end up blowing that money six ways to Sunday at least three times over in our minds.
But now think about your family’s financial obligations, starting with your kids’ college funds. How nice would it be to be able to keep your kids from having to take out student loans? What if you could pay off your house? That would be $800 a month you could put into a savings account or an account at Scottrade, plus you’ll save a boatload of interest in the process. So what about the stock market?
Now if you’ve been listening to the news, it may appear that the stock market is a pretty scary place. One day it’s up, the next it’s down, and nobody seems to know when and where it’s going to end up. It’s one of those places that the average Joe now looks upon suspiciously since things got out of hand during the latest financial crisis.
On the other hand, think about how you could get a better return on your money if you thought about investing it over the long term, perhaps putting it aside for the next six years to be part of an investment portfolio, rather than socking it away into a safer, stable checking account, which by the way, you may be tempted to raid every time you want or need something.
To make heads or tails of how next to proceed with your newfound fortune, here are a few things to look into:
Create an emergency fund, if you haven’t already.
It’s common wisdom to have at least six months’ worth of bill-paying funds available in the event of an emergency. If ever there was a time to establish this fund, now would be it. If you’ve got $50,000 coming your way but don’t have any savings, why not deduct $12,000 (this is just an arbitrary amount) from your windfall and open a money market or savings account, say at an online bank like EverBank, which has higher minimum deposit requirements but typically higher interest rates? You can decide to link this to other accounts you have, for quick access. Or you can create an account at your local bank or credit union if you’re much more comfortable with face-to-face customer service.
Invest in a diversified mix.
You can get started with investing your funds by splitting the rest of the balance into stock mutual funds and bond mutual funds. While the earnings potential of this portfolio is a little less than what you’d get if you took a more aggressive stance, you’re managing your risks this way and protecting yourself against big losses.
Visit a financial planner.
If you’re not sure about how to handle a significant windfall, you may want to get a professional’s advice. This is one option to take, especially if you are used to a paycheck-to-paycheck existence and now have the motivation to improve your financial situation. With money in your hands, you’ll need a realistic budget and some motivation for sticking to it. You can certainly do all of this on your own, which would be the low cost way to go about it; but for those who feel the need for extra support in this area, seeking someone you can trust and are comfortable working with may prove helpful. (Read “How to Choose A Financial Planner.”)
Your financial advisor will likely suggest that you come back and see him (or her) after some months, the idea being that he or she can help refine your investment strategy and capitalize on your windfall by making more aggressive investments. They’re around to help you through the process of working out your financial picture. Use this opportunity as a way to learn what you can from your advisor and to get started on the road to a healthier financial life.
Ronald Dodge says
December 2, 2010 at 6:34 PMIn 2009, I did receive an inheritance though not in the neighborhood of 50,000, but more like 15,000. Even with that, it did get me over the next hump or 2. I essentially paid off one debt (though not entirely so as not to get hit by the early payoff penalty, but also had to be smart about it so as not to have the last due date outside of the time period when I can avoid the payoff penalty). I did up the long-term assets a bit. I used a specified amount as stated in the Will for entertainment. This also helped replenish the emergency fund. In 2009, we weren’t really struggling like we were in 2005 thru 2007, but it was still a scary time as I didn’t like the signs I saw at work. Sure enough, 74% of the work force got laid off in spring of this year, but I made it through. Now the money that I was earning from overtime and my wife was making in the August-October time period, we did majorly ramp up the emergency fund with that extra money.
Now we have made other strides since then, though still not easy. Of course, as debt drops, meeting that 25% of actual gross income to go to countable savings will get easier and easier to meet. As such, so will meeting our daily residual improvement amount goal become easier. Ideally, I have plans to be totally out of debt by 2018, but will that happen, not entirely sure. More than likely, yes, but you just never know with regards to inflation vs pay increases as real pay increases (taking into account benefit levels as how the value of such benefits has either costed a lot more or the value of such benefits really dropped or some combination of both) has NOT kept up with the rate of inflation. As such, I was forced to look for other sources of income and that’s when I turned to investments via Scottrade (coincidentally what’s referred to in this article).
DIY Investor says
July 13, 2010 at 1:38 PMThe advice here is pretty good. Especially pay off high interest debt and then stay out of debt! Too many people pay off the debt and then a year later are in the same boat.
Here’s a thought that doesn’t often occur but is worth thinking about for some people. After you have taken a deep breath and your mind has stopped racing reflect for a moment about where the inheritance came from. Someone thought enough of you to leave part of their estate to you. This is special! Maybe think of setting aside a small amount of the inheritance to take the family out to dinner and remember that person.
Something I’ve recommended to many people and , believe it or not, something that many never think of.
Doug Warshauer says
July 13, 2010 at 9:40 AMInteresting post, SVB. Here is the rule of thumb I’d suggest people follow in terms of allocating an unexpected inheritance:
1. Fill emergency fund
2. Pay off debt
3. Put money into an “auto fund” to pay cash for your next car
4. Put money into a “home fund” to make a down payment on a home if you don’t own one now and plan to own one someday
5. If you have children who you expect to go to college, put money into a “college fund”
6. Put what’s left into a retirement fund.
Of course, this rule of thumb ought to be adjusted for personal preferences. In general, it is based on a sequential prioritization of your dollars: put your money first toward the items you will need first. It’s the best way to stay out of debt and build toward a wealthy future.
benjamin bankruptcy says
July 13, 2010 at 6:08 PMDoug, I just don’t understand the emergency fund dogma. Why when you get maybe 2% on your savings wouldn’t you pay down your credit card with and interest rate of say 15%? Arn’t they 13% worse off every year for not paying down their credit card? That money isn’t permanently gone, if a true emergency comes up they can use the credit card again. A credit card isn’t a crack pipe, one hit and you’re back on the wagon?
Doug Warshauer says
July 14, 2010 at 7:07 PMBenjamin,
I can’t argue with you. (Notice I didn’t specify an amount for the emergency fund.) Many people just feel more comfortable knowing they have money at their finger tips, and that psychological benefit is worth the financial sacrifice. Also, in the case of job loss you may lose access to credit, so if that is a possibility the emergency fund does have real value. But if you are confident your ability to access credit will remain in a situation where you need it, and if you don’t need money in the bank for peace of mind, than a minimal or even zero emergency fund would be fine.
benjamin bankruptcy says
July 15, 2010 at 5:12 PMFair point. I’ve just read a post about how banks can reduce your credit limit in the states? If this is true than an emergency fund may be an option. Down over here in Aussie the bank can’t dial down your limit so when I give advice to clients to pay down the credit card with every dollar they have the advice is more sound.
Ronald Dodge says
December 2, 2010 at 6:19 PMI hope you not suggesting a separate fund for home stuff vs auto stuff vs other emergencies. If that’s the case, then you can’t do as much with the money separated from each other.
For me, I lump all 3 into one. As for the Home, Auto and other long-term assets, I use depreciation schedules to determine what needs to be put into the emergency fund. However, the emergency fund is not just some saving account or money market account with very low interest rate. I will keep a small amount in a such account just for those times when a small amount that I had potentially forgotten about or didn’t catch in time is going to be covered by that small cushion, but that’s about all I keep in a such account along with what’s planed for the current rolling one year out as shown via the cash flow management worksheet. Anything beyond that goes to an investment account as for the 3 funds you mentioned among what you would have created as a 4th fund, other long-term assets fund.
As for college vs retirement, I’m in the camp to fund retirement before funding college cause no one else is going to pay for your retirement vs with college, there are certainly other things out there for it. Ideally, you stress and get your kids to do very well in school (get into and stay in the top 10% academically), so as they can get academic scholarships. I don’t know about the private school sector, but it’s not that hard to do within the public schools as most students don’t put forth the effort needed. For me, I did graduate in the top 10% of my high school class (10th out of 115 students) and got a partial academic scholarship. The only reason why I didn’t get the full ride, I needed a minimal score of 28 on my ACT out of a possible of 31, which I got 25 on the ACT. But then it was in English and History that hit me hard on it, but then my LD was primarily in language. Hecks, for that matter, 6 of my 25 credits (yes, I had one extra credit my senior year as compared to most students given I took that one extra course) were in Accounting and Computers at a vocational high school, which the accounting stuff were equivalent to the sophomore level of undergrad college Accounting. The only difference, it was taught from the bookkeeping point of view instead of from the financial statement point of view, but otherwise, the course materials were no different. How do I know this, I was forced to retake it again in college as they didn’t accept it from high school and other than it was from a different perspective, none of the 3 college accounting courses in the sophomore year taught me anything new as I already knew all of those items inside out from when I had it in high school.
Split Cents says
July 13, 2010 at 5:01 AMGreat article! For me at least, inheritance / windfall would also be a great way to knock out some student debt!