One of the best problems to have in life is to have a lump sum of money that you don’t know what to do with. You could have inherited this money, won it in a lottery, or perhaps more likely — earned it over a period of time and never invested it due to inertia.
Obviously, there are many variables that need to be considered before you decide how to go about investing a lump sum amount but there is a framework that you can rely on, and I’m going to write about that today.
Shiv and I did this exercise for a couple of clients recently so I’m relying on the work we did there and generalizing it to fit to a larger audience, but if you feel that I’ve missed taking into account any parameter, please leave a comment, and I’ll respond to it.
How big is your lump sum amount, and do you have enough stashed away for an emergency fund?
Everyone should have an emergency fund which should be at least six months of your expenses in a savings account or a liquid fund, and if you don’t have one then you need to fund that with your lump sum amount immediately.
What is your asset allocation?
After funding your emergency needs, you should look at your current asset allocation which is broadly categorized as follows:
- Real Estate
If you determine that you need to put more money in real estate or debt — you can invest your lump sum amount in your choice of asset in this category at one go since these are relatively less volatile asset classes, and in any case you don’t really have a good option to invest in real estate in a staggered manner.
However, if you determine that you need to invest in gold or equity then you should use a more staggered approach that protects you from market volatility.
Invest in a Debt or Liquid Fund and then use STP to Diversified Equity or Gold Funds
I say that you should use a staggered approach but it would only be fair to mention that this is a matter of opinion and not fact. A lot of people consider investing a big amount all at once better because the equity market tends to go up more often than it goes down, and if you work with that as your guiding principle — it is better to have invested all your money at once, and make it work for you from the very beginning. This Morningstar article illustrates why investing a lump sum at one go can be numerically better than a SIP approach with the help of an example.
That said, I wouldn’t follow this advice with my own money or recommend it to anyone else simply because the risk outweighs the benefit in my opinion. If I invest 20 lakhs in the market tomorrow and it falls by 10% in the next couple of months — it will take me a signficantly longer time to make that amount back than it would take me if I just invested a little every month, and bought more units during the time of market falls.
The most practical way to make this work is to buy a couple of liquid or debt funds, and then start a STP (Systematic Transfer Plan) from them to fund a diversified equity fund, or a gold fund over a period of 18 to 24 months.
This can be easily and cheaply done with the usual trading accounts that most people hold and is one of the best ways to invest a lump sum of money.