Most households plan to live on their regular income, which usually comes in the form of a monthly or weekly paycheck. However, there are always the occasional windfalls when you receive a large amount of money that you may not have been expecting. Some common lump sums come from inheritances, bonuses at work, tax refunds, court settlements, or the sale of investments. If you receive a lump sum of money, it's important to consider how you can use it to achieve your financial and personal goals.
Pay down debt: One of the best long-term investments you can make is to pay off high-interest debt now. This is especially true of credit card debt, which is likely costing you between 10% and 15% a year, which is much more than you can reliably make by investing your money. If you can't completely pay off a credit card, even just paying down the balance makes a big difference by reducing your interest costs each month going forward so you can pay off the credit card faster.
Build your emergency fund: Every household should have at least $1,000 saved in an easily accessible emergency fund. That way, if urgent expenses arise, like a car repair, home repair, or need to travel, you have the money available and won't have to turn to credit cards to cover the cost. To protect against job loss, you should ideally have 3-6 months of basic living expenses saved to cover the regular bills while you look for other work.
Save and invest: If you are in a good place financially right now, then it is time to consider how you can make your lump sum of money grow to support you better in the future. Some options in this category include:
- Take a look at your retirement accounts and consider whether you are on target with your retirement savings. If not, your windfall could go there, and depending on the type of account, a tax deduction for making that contribution may be available.
- If you are looking to buy a home soon, save some or all of your money to use as a down payment and to cover closing costs. Switching from renting to owning can be a significant financial boost, depending on your specific situation.
- Invest the money yourself so it can grow and you can use it in the future for whatever your wants or needs might be. A balanced portfolio of stocks and bonds tends to get fairly consistent returns over the long run.
Treat yourself: Even if you use most of the lump sum for one of the above purposes, consider holding back at least a little of it to spend on something that you have wanted for a long time. Perhaps you have wanted a new TV, new furniture, a vacation, or even just a weekend trip. Spending some money on yourself can give you an emotional boost rather than feeling resentful that you didn't get to use the windfall you received.