Following Tisha B’Av, we begin a series of seven haftarot of consolation (Shiva D’Nechemta) leading up to Rosh Hashana. These readings, all from Isaiah, offer messages of redemption and divine reassurance after the sorrow of the Three Weeks and Tisha B’Av. This weekend, Shabbos Nachamu, in particular marks a spiritual turning point from mourning to comfort.
In the financial world, few things offer more comfort than receiving a large sum of cash. The challenge is how to handle a windfall responsibly based on the markets, economic environment, and personal circumstances. Below is a framework that may be helpful to ensure your large inflow of capital, irrespective of whether from a sold business, large gift, life insurance settlement, bonus, or inheritance, is being handled responsibly:
Pay Off Debt: An important first step after receiving a large windfall is to assess your overall finances. If you borrowed any money, you should consider paying that off first. It’s very difficult to grow your wealth while you have an onerous level of debt weighing you down. Credit card debt, student loans, and auto loans are all bad and should be paid off as soon as possible. Conversely, a low-rate fixed mortgage on your primary residence and some forms of business debt can be paid off more slowly. Once you relieve yourself of your burdensome debt, you can explore the best way to invest this capital.
Do NOT Time the Market: Since the market is around all-time highs as of this writing, some investors may consider the idea of waiting for the bottom of the next bear market to invest their money. On the surface, waiting for stocks to drop by 20% in order to buy things on the cheap seems like a great idea. In practice, this strategy is impossible. There is no way to perfectly time the market. Even if the market did fortuitously freefall just before you had a large pool of capital to invest, most people would still hesitate to start investing. Their psyche would tell them that the market can always fall further. Furthermore, markets tend to rise three out of every four years. Even though the market is currently at a high, it has a probability of continuing to rise going forward, so there is no need to be concerned about investing at a market high.
Diversification Is a Must: Choosing to have exposure to a variety of investments is always imperative. While the U.S. market has been setting record highs, it also has experienced large periods of underperformance. Additionally, while most global markets have not had such a good run over the past decade, they have outperformed the U.S. this year. The same is true for various asset classes and sectors, whose performance moves in cycles. Maintaining a diversified strategy when deploying capital can minimize volatility, risk, and offer a higher probability of achieving your financial goals. Investors should always pursue a strategy of diversification across geographies and asset classes.
Understand Your Time Horizon: The most important factor in managing money is understanding the time horizon for when the money will be needed. It sounds basic, but very often this concept is overlooked. Determine your investment strategy with the end in mind. If you need your money in the near term to make a down payment on a house, then investing in venture capital or growth stocks should be avoided. Stick to something safer, like a money market account or short-term bonds. On the other hand, if you have a multi-decade time horizon, you may wish to invest a portion of your portfolio in volatile small-capitalization growth stocks that may appreciate significantly over time. An investor’s liquidity requirements are essential to determine any investment strategy.
Percentage of Net Worth: Objectively, the amount of new money to invest may be large, but it’s important to consider its size relative to your total savings. For example, inheriting $500,000 when you already have $2 million saved for retirement comes with different considerations than if you have $250,000 saved.
If the figure is less than 25% of your investable assets, then it may make sense to invest it all at once (after paying off your expenses) in a similar allocation to your current portfolio. It is a relatively small sum of money, stressing over when to invest it won’t necessarily change your current or future lifestyle. If these funds are more than 25% of your nest egg, then you should consider whether it makes sense to invest the lump sum or dollar cost average over time.
Investing the Lump Sum vs. Dollar-Cost-Averaging: Deciding whether to invest the entire lump sum at once or spreading it out over time relates back to time horizon and not trying to time the market. Since the market’s long-term trend is positive, mathematically the best course of action for an investor with a multi-decade time horizon, whose specific risk tolerance doesn’t indicate otherwise, may be to invest the entire lump sum immediately. This will allow them to buy at lower average prices, which may allow them to outperform a strategy of slowly adding money over time.
Psychology is also a factor in the decision. Folks who are nervous about the market and can’t stomach adding a substantial level of funds all at once may be better off setting up a systematic approach to add money to their portfolio at pre-determined intervals. Dollar-cost-averaging allows investors to get their money invested over time without letting their emotions derail their finances. While this approach may not lead to the best investment performance relative to lump sum investing, having peace of mind is also an important consideration.
Approaching Retirement: Folks who are retired or who will be retiring shortly need to be the most careful with their investment strategy on a new inflow of assets. Investing a large sum of money right before you stop working and then experiencing a major market downturn can be devastating. This “sequence of returns risk,” or the risk of experiencing a string of unfavorable returns as you begin to draw down on your portfolio, is a very difficult scenario from which to recover.
A good example of this was during the 2008-2009 Great Financial Crisis. Some soon-to-be retirees had their 401(k) invested much too aggressively or too concentrated in their own company stock. The market downturn and fragility of the financial system was devastating. Instead of retiring as planned, some of these people got wiped out by the market crash and were forced to remain working for much longer.
One way to invest that manages for sequence of returns risk is to set up a “bond tent.” This strategy keeps a few years’ worth of expense money in very short-term high-quality bonds or cash. The remaining assets can be invested in the market, perhaps more aggressively, according to the individual’s various other goals. Should the market have several years of subpar returns, the investor won’t have to liquidate their more volatile holdings, like stocks, at a steep loss. Rather, they will be able to use their cash cushion or high-quality bonds to meet their expenses as they wait for the market to recover.
Keep for Yourself vs. Give to Others: The desire to give is imbedded in most Jews, with tzedakah and helping out children part of the genetic makeup. The question is how much of this windfall should be used for your own benefit and how much should be given to help lift up others.
If the funds came from an inheritance, sale of a business, sale of real estate, or a bonus, then I’d recommend giving 10% of the net proceeds to tzedakah immediately. It’s a mitzvah and a core part of our being. However, funds that came from a 401(k) rollover into a new plan or into your IRA should not be taken out before a certain age to avoid being subject to unnecessary taxes and penalties. Since 401(k) funds were already your assets, and not a new source of income, no additional maaser needs to be taken from them.
As for helping family remembers, remember the concept of “pay yourself first.” This simply refers to the fact that failure to make yourself a priority, in this regard, can lead to challenging financial consequences in the future. Once you have taken the steps to ensure your own financial well-being, it is up to you how much you want to give your children to assist them in their own finances.
Don’t Do Nothing: Indecision has a price. Don’t sit paralyzed in cash while contemplating your next move. That paralysis will have the negative consequences of losing buying power with inflation and missing out on compound interest. It may lead to other unfavorable ramifications of not taking a proactive approach to your finances. Remember, if your financial windfall was tied to a business or to real estate, there was already risk associated with this capital. The fact that the proceeds can now be diversified among a variety of different asset classes is a wonderful opportunity that should be seized.
Receiving a large windfall is a blessing, but the stresses associated with how to manage these funds properly can feel overwhelming. Take the opportunity to touch base with your tax, legal, and financial advisors to get their advice on your updated financial situation. It’s also a good time to revisit your overall strategy and possibly update your Investment Policy Statement. Speaking to your trusted advisors to develop a sensible approach can remove the decision-making stress and ensure that your funds are a source of comfort and simcha for you and your family.
