What to do with a lump sum of money

What to do with a lump sum of money

Sometimes, you get a bit of money over time. In other times or rare times, you might get a lump sum.

What should you do with any financial windfall?

What should you do with a lump sum of money?

Is it better to invest a lump sum of money or dollar-cost average over time?

Read on and find out my takes inspired by a recent reader question.

Congrats, you have a lump sum of money. Now what?

A lump sum of money, no matter how small or large, can be a huge enabler to your financial goals or current needs.

Small sums of money can help fund savings for near-term expenses like a car or a desired vacation.

Large sums of money can be life-altering. 

With so many options and ways to spend money, I think it’s worth knowing and therefore figuring out what’s going to give you the most value for your money. Inspired by a recent reader question, I highlight some ideas on what to do with a lump sum of money.

Reader email and question (adapted slightly for the site):

Hi Mark,

Love your website, I’m a regular visitor and reader. I’ve been a dividend investor since 2001 (eek 20 years!), letting XIU dividends DRIP away and accumulate in my non-registered account, more variety in my RRSP/TFSA account where ACB (adjusted cost base) calculations are not required for myvtax returns. I’m shocked at how much advisors charge to manage people’s money and encourage anybody that asks to learn about investing or DRIP index-based ETFs.

(Mark: heck ya, tell me about it!)

My suggestion for an article is a discussion on what to do with a windfall. Pay off debt, top up TFSA/RRSP, and more come to mind. I found it was very useful to be a DIY investor because your game plan is already developed and in progress. Recently, I was able to deploy funds according to my plan and found it
pays to be on top of your investments, you already know where you are headed.

Thanks for any insights if you can do an overview on that!

Thanks for your readership and question.

I think this reader is very wise to consider how any sum of money (big or small) fits into your financial plan or roadmap. With that in mind, here are my key considerations on what to do with a lump sum of money.

1. Incorporate your new money into your existing financial plan

Odd, right: new money, old plan?

Not really. 

If you already have a financial plan in place, then this decision will be rather easy.

Any new money should already be earmarked where and how that will fit into your financial plan – enhancing your savings, accelerating your money goals including financial independence or any destination in between.

Having a financial plan will give you some objective reminders where this money could go, and why, effectively doing two very important things at once:

1. Using your new money most effectively and tax-efficiently, and
2. Reducing the likelihood of making a poor, emotionally-driven decision.

If you don’t already have a financial plan or know what should go into any financial plan, then consider further reading here.

What is a Financial Plan and what should it cover?

Assuming you have a financial plan or at least a good financial roadmap in mind, these might be some options for your lump sum windfall.

2. Max out your Tax Free Savings Account (TFSA)

My reader did not disclose how much new money they are talking about, so I’m going to assume it’s a small six-figure ($100,000) sum.

With that amount of money, I would absolutely encourage any adult Canadian (if they haven’t already done so) to max out his/her TFSA contributions. 

I mean, love the account and totally dislike the name! 🙂

I hope you know from reading my site the Tax-Free Savings Account (TFSA) is far more than a savings account, and unfortunately, many Canadians still cannot get over this fact. Check out these facts from earlier this year according to a Bank of Montreal (BMO) study:

• Cash is good, but…the majority (56 percent) of Canadians polled at the time have cash in their TFSA and 29 percent say cash makes up at least three-quarters of their holdings. That’s a major loss in stock market compounding power!
• Knowledge is power, but…while 73 percent of Canadians consider themselves knowledgeable about TFSAs, only half (49 percent) of Canadians are aware that a TFSA account can hold both cash and at least one of the other investments. There is certainly much more financial literacy in Canada needed!
• If you don’t have investing goals how is investing going to get you there? Many Canadians primarily use their TFSA accounts for various financial goals, with 44 percent using a TFSA for retirement savings, 43 percent using it as a savings account, but just 15 percent using the account as a means to achieve financial independence as early as possible.

Full stop: while the TFSA can absolutely be used for short-term savings I believe maxing out contributions to your TFSA (or your partner’s TFSA) and investing inside the TFSA with equities can be an excellent way to build wealth – including making great use of a financial windfall. 

3. Max out your Registered Retirement Savings Plan (RRSP)

While I personally prefer maxing out the TFSA over the RRSP, for almost anyone in any income bracket, contributions and maxing out the Registered Retirement Savings Plan (RRSP) is also one of my favourite accounts to build long-term wealth with, and so I do use it!

I think with any large or modest lump sum windfall, after the TFSA is maxed out then put any tax-deferred RRSP compounding power to work.

4. Kill off mortgage debt or reduce mortgage debt so it becomes manageable

If you’re nearing retirement and still have an amount owing on your mortgage, you might want to consider dumping your lump sum windfall on your mortgage.

Debt can be crippling for many, including as inflation and interest rates run higher over time.

While you don’t need to be debt-free to be financially free, debt management is however key. 

Of course, I believe there are several reasons not to pay off your mortgage aggressively, and instead, consider an investing first/balanced approach to managing debt and investing. Here are three reasons that come to mind:

• Don’t kill off your mortgage when borrowing costs are cheap. While I believe it’s prudent to pay down debt in any interest rate environment, one could argue that there is no urgency to kill debt if your borrowing costs are very low. Use that money to invest, instead.
• Don’t rush to kill off your mortage if/when long-term investments should outperform low-interest rate mortgage payments. Related to my point above, by maintaining your minimum mortgage payments, and putting your extra funds into long-term equity investments, chances are you will come out ahead with investing over many investing years. Although past performance is never a perfect indicator of any future results, a diversified mix of investments over a 20-25 year investment time horizon (approximately the same period as your mortgage amortization) should deliver close to 7-8% return. I don’t see real estate getting that! This would be by far and away more money earned than any amount you’d save in interest charges by paying off the mortgage early – all things being equal.
• Liquidity. Have you ever tried to sell a home in a few days, AND move out AND do something with that money right away? I wouldn’t bet on doing that successfully. By having your assets invested beyond your primary residence or rentals, you will have more liquidity should you need the money for something.

What to do with a lump sum of money summary

A lump sum is when you get a large amount of money at one time  – and the sources can vary:

• An inheritance of money
• A sale from real estate
• Winning the lottery or another fun contest!
• A severance payment if you lose your job/if your workplace changes
• A life insurance payout 

Many recipients of a lump sum of money may feel a blend of shock, excitement and anxiety. That’s normal and a good problem to have…!

If you manage a lump sum financial windfall wisely, you can probably enjoy some short-term fun, take advantage of long-term investing power, pay off some debts and/or all the above. 

Have you ever received a lump sum financial gift? If so, what was it and how did you deal with it?

Further Reading:

What is better? Dollar-cost averaging or lump-sum investing?

ETFs and dividend stocks to build wealth with.

Learn why The Psychology of Money matters when it comes to mastering money management.