How to Invest a Lump Sum

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Congratulations – you’ve just received a lump sum. Perhaps you received a huge commission check, a bonus, a gift or an inheritance. Or maybe you’ve been absentmindedly saving for awhile, and now your bank account has reached a new high.

It’s time for you to harness this money. You shouldn’t leave a huge lump sum sitting in a checking account. But what should you do?

In this article, we’re assuming that you’ve paid-off all of your high-interest debts, like credit card debt, and you have a healthy emergency fund. You’re ready to invest your lump sum. What should you do next?

Pick a Vehicle

First, pick an investment vehicle. Your top priority should be to maximize the employer match within your 401k.

On the surface, that might not make sense. After all, you can’t directly invest your tax refund check into your company 401k.

But you can indirectly do so. Ask your HR department if you can crank up your 401k withholdings from your paycheck. Live on the tax refund money as a substitute for the paycheck earnings you otherwise would have received. Voila – you’re indirectly investing your tax refund into your 401k, and you’re gaining an employer match, to boot.

You can choose two paths: either temporarily ratchet up your 401k contribution sky-high for a single month, or meter out higher contributions over the span of a year.

If you’ve already maximized your employer 401k, consider investing your tax refund into an IRA. You can choose either a traditional IRA (in which your contributions are tax-deferred) or a Roth IRA (in which your gains are tax-exempt).

IRA’s hold the advantage of having more flexibility than many 401k plans. You can open an IRA at any brokerage of your choice, and you’re more likely to have a multitude of fund options (as compared to limited options within your 401k). You can also choose whether you prefer a Traditional or Roth tax strategy.

Regardless of whether your invest your tax refund in a 401k, IRA, or other type of investment vehicle, opt for a tax-advantaged account if possible. Tax-advantaged accounts hold a much stronger benefit than taxable accounts.

Choose Your Asset Class

Are you properly diversified?

That’s a tricky question. Your portfolio is a pie, and each “slice” – divided between equities and fixed-income investments, and further subdivided by style, size and geography – should hold a different weight.

The size of each “slice” should reflect your age, goals, timeline, risk tolerance and other unique factors. There’s no one-size-fits-all approach.

Do you know the right allocation for your circumstances?

If you’re not sure of the answer – or if you want to better understand how your tax refund plays a role in your overall portfolio design – use an unbiased service like Jemstep, which can help you design a more secure retirement portfolio.

Buy Into Your Under-Exposures

If you use Jemstep’s service, you might discover that you’re under-represented in certain asset classes.

Maybe your portfolio needs more emerging markets, or small caps, or Treasury bonds.

You can use your tax refund to buy more investments within those asset classes that are lagging in your portfolio. This will bring you closer “in line” with your ideal balance.

Monitor

Finally, monitor your performance. You should always be watching your portfolio – regardless of whether you’re investing a tax refund or not.

Don’t get caught up in day-to-day fluctuations. But do check your balances at least quarterly, and rebalance at least once a year. This will help you keep your portfolio on-track.

Investing a lump sum is a great opportunity to beef up your investments. Choose your investment vehicle wisely, maintain solid diversification, and enjoy the long-term fruits of your labor.