Whether you want to invest a 401(k) or IRA rollover, a tax refund, an inheritance, or you win the lottery, there are a few smart ways to best manage a large amount of cash, no matter what the stock market or economy is doing at the time. Here's what to do before and after you receive your money.
Determine the Best Short-term Depository and Vehicle for Cash
Depending upon how much money you are due to receive, and assuming you have a little time before you receive your cash or check, you will be wise to begin looking for a place to hold your money and to research savings vehicles or security types to invest your cash.
It is possible that you will have more than one use for your cash windfall. For example you may want to pay off debt with a portion, give some away, use some for a well-deserved vacation, and use the remainder to invest for retirement. Any amount you will not use within a few weeks time can begin earning interest.
In most cases, you will invest in a money market fund for short-term cash needs. Money market funds are interest-earning savings vehicles that are liquid, which means you can generally deposit and withdraw from them at any time without penalty or fees.
Investors can typically buy money market funds at mutual fund firms, brokerage firms and banks. Vanguard Prime Money Market (VMMXX) and Fidelity Cash Reserves (FDRXX) often have among the highest yields for the larger, well-known financial institutions.
Savers and investors can also find some of the highest yielding money market funds in the nation at Bankrate.com.
Decide What You Want the Money to Do For You
This may sound too obvious but you need to have a vision or structure for your money, or what will eventually be your investment portfolio, before you invest it beyond the money market fund. Similarly, you don't want to leave your cash in a liquid savings vehicle like that for too long or you may be missing an opportunity to make your money work harder in something more appropriate for the task at hand.
A financial planner might call this vision or structure your investment objective.
Lump Sum Invest vs. DCA: Jump In Now or Slowly Invest It Over Time?
Whether you put all your cash to work immediately or periodically invest portions with dollar-cost averaging (DCA), you need to make your decision completely upon your investment objective and risk tolerance and not what is happening in the stock market or economy at the given moment.
For example, if your time horizon is 20 years, you can invest the entire lump sum of money into your chosen investments all at once. This is because the total return over that long of a period of time will not change much by timing this far in advance. Also, there is more risk of decreasing your average returns by leaving too much of your cash in a money market account, as opposed to investing it immediately.
People who may want to DCA into their investments include those who have low risk tolerance and/or those investors whose time horizons are not clear. For example, a person in their 60's who is saving for retirement, may still have a 20-year time horizon. However, they do not know with certainty how long they will live. Therefore, this person may want to DCA their lump sum into their investments over an extended period of time, such as one to two years. This way, if there is a dramatic decline in stock prices, the investor can minimize losses and maximize future returns by investing a specified amount, once per month, over a several months or a few years.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.