What to do with a windfall

It’s a problem most people would love to have: what to do with a cash lump sum. Do we blow it on a dream holiday, make like James Bond at the Casino Royale, head for the nearest racecourse to make a wild wager, or do we invest it in something that will make it grow? For those taking the sensible option, there are a number of ways to make your money work for you.

“There is a number of steps to go through before investing a lump sum,” advises Bank of Ireland head of pensions and investments Bernard Walsh. “Firstly, you need to understand the money you have and get a good view of where you are now. Have you enough for short- and medium-term needs? Second, have you an emergency fund to cater for the known unknowns, those unforeseen things that can come up? After that, you can isolate your investment money.”

The next step is to decide on investment goals. “What do you want from your money?” Walsh asks. “If you are saving for the deposit on a house you want to buy in two or three years’ time, that’s not investing. You need at least a five-year time horizon. Once you decide on your goals you can make a plan to get there.”

RBC Brewin Dolphin Ireland head of investment strategy Ian Quigley advises every investor to go through an assessment of their risk appetite to understand how much market volatility they can take. “That should go without saying,” he says. “Over time, equity markets have proven to give the best after inflation rates. But, like last year, you can get high levels of volatility. You need a long-term investment time horizon to be able to withstand that volatility.”

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He notes the recent improvement in bond yields and deposit interest rates, but not to a level that can match inflation. “For the first time in many years, people can get a positive return from government bonds and bank deposits but they are still below inflation. Last year, German government bonds were negative, and they are now around 2 per cent. We have been used to rates going down for the past 10 years. We have gone from a zero or negative rate world to one of positive rates. Albeit with income yields still below prevailing inflation.”

Yields on other asset classes like listed property funds have also risen but at the cost of falling valuations. Quigley explains that if investors were getting a 4 per cent yield from a particular asset and now want to get 5 per cent to reflect a higher risk associated with it that translates into a 20 per cent reduction in the capital value of the asset if the income it produces doesn’t increase.

That may make investments in those assets attractive at present but Quigley counsels caution. “You need to be careful about leverage though. Some of these funds have high levels of borrowings and may need to go back to the markets to refinance these at higher rates or they may have to raise fresh capital from shareholders.”

The best approach is to build a blended portfolio of assets comprising equities, infrastructure, property, and bonds, he advises. “You still need to understand your risk appetite. If there is a 20 per cent fall in the market and you sell because you fear further losses, you can end up turning a temporary loss into a permanent one.”

Risk profile

Invesco investment director Richard White agrees: “One of the key principles of investment is to maintain the purchasing power of your money. And the best way to do that is through a diversified multi-asset portfolio. But you need to look at your risk profile. You shouldn’t go into a medium-risk profile if you are very cautious by nature. More cautious investors will have to accept that their investments will not keep pace with inflation. More cautious funds will contain more bonds and cash which will offer below-inflation returns. Diversified multi-asset portfolios are available from any adviser, banks and so on. They will have funds that suit the risk profile of individual investors.”

These multi-asset funds will contain different asset classes but will also offer diversity within them to spread the risk. “Most multi-asset portfolios will have between 2,000 and 2,500 different stocks in them, so you are not exposed to any one sector or geography,” White notes. “That is investment as opposed to gambling. Friends and neighbours often ask me about individual stocks. I tell them I wouldn’t know, that’s gambling — investing is not about taking a punt on an individual stock.”

Walsh points out that there is a wide range of choice available for people with lump sums to invest. “There are with-profits funds that offer a consistent steady return over time. Multi-asset funds offer wide diversification. And there are funds that offer a degree of capital security. But you should take advice before making any decision.”

Of course, you don’t necessarily have to put the money in the markets to make it work from you. “Paying down high-interest debt is probably unbeatable in many instances,” Walsh notes. “You have to look at the trade-offs. Maybe paying off credit card debt or accelerating mortgage payments is best for the individual. Or it might be that putting additional voluntary contributions into a pension scheme for tax-free, long-term growth could be the better option.”

Ultimately, it comes down to the individual’s circumstances, needs, goals, and risk appetite. But the best advice of all is to get professional advice first.