Increasing our savings and making good investments helps us increase our wealth. While this is true, we also become wealthy from a sudden cash lump sum.
This usually occurs 1 of 3 ways:
1) Selling a Business
- At some point, entrepreneurs sell their business (hopefully for a large amount). How to manage the proceeds of the sale depends on the age of the entrepreneur. As the strategy for someone in their 30s is quite different from that of someone in their 60s. It is best to speak with a Certified Financial Planner before deciding on a strategy.
2) Winning the lottery (either by Birth or Lotto Ticket)
- You can win the lottery in a few different ways. One involves a trip to the gas station and buying a lotto ticket, the other is being born to wealthy parents. Both pose the same challenge as selling a business. Timing, once again, is of critical importance.
- If you are in this group you may already have enough money to last you a lifetime. So why not be proactive and solve this problem for your [future] children. Inter-generational wealth comes from life insurance, structuring trusts, and other estate planning tools. It is healthy to discuss this as a family. You can find out more here about succession planning.
3) Taking a Pension Lump-Sum at Retirement
- In some cases, employees have an option to take a lump-sum at retirement instead of an annuity payment.
While it may sound ridiculous, receiving a lump-sum of cash is stressful. Especially when the markets are as uncertain as they are today. So what are your options? Do you invest all the money right away? Wait until the next market drop? Invest it in phases?
When it comes to financial planning, there is never a one-size-fits-all answer. So our answer, as usual, is that it depends on your life goals. What do you want your legacy to be? Do you want to retire or continue working? Do you want to buy a yacht or a plane?
Answering big life questions like this can be tough. But the good news is that regardless of the answers, the planning process is the same.
You start by building the pyramid.
Before we go out and buy a yacht, we need to plan for 3 things:
1) Short-term Security
How much money will you need to fund your (new) lifestyle? Will you make any major purchases like a vacation home or a new car? What about a trip around the world?
After establishing these new living costs, we create a financial plan to meet these needs. This plan needs to produce and protect your monthly cash-flow. This gives you short-term security.
2) Long-term Security
Next, we need a game plan to invest our remaining cash and establish long-term security. We achieve this by protecting ourselves from inflation and taxes, as both decrease the value of our lump-sum over time.
With a longer time horizon, we can outpace inflation with higher-risk investments. As these investments offer us a higher rate of return.
With the use of tax-shelters, we can further protect the value of our lump-sum. Tax shelters available to us include both registered investment accounts (TFSA/RRSP) and Investment Life Insurance.
3) Succession Planning
Our last step is to determine how much money may be leftover and what to do with it. There are many different strategies when it comes to legacy planning. Your goals dictate which one is best for you.
But legacy planning isn’t something you do in an afternoon. Our clients use the Willing Wisdom™ Index, an easy-to-use tool that makes drafting your will an easier process because you get clarity before meeting with a lawyer. The report is 100% confidential – no one receives the checklist, except you. Our team has made this checklist free for your benefit. It will take approximately 10 minutes to complete. Click here to get started.
The Egyptians built the Pyramids to stand the test of time – this should be true of your financial pyramid. If you want your lump-sum to last, avoid these common mistakes:
Some Common Mistakes To Avoid
1) Waiting for the perfect time to invest
Market timing is foolish because even the best investors can’t predict if the market is moving up, down, or sideways next month. Even worse, you lose money from inflation when cash sitting in the bank.
2) Playing Lifestyle ‘Catch-Up’
We see this all the time. To build their business, an entrepreneur will sacrifice their lifestyle. So when they exit the business – they try to ‘keep up with the Joneses’. Besides overspending, this can also result in taxation issues. Like buying real estate without setting the proper corporate structure. This type of planning can take time, but it will save you costs and headaches in the future.
Now that we know what to avoid, here are a few different ways to invest your lump-sum.
1) Investing It All At Once
Clients often question whether they should invest their lump-sum in phases or all at once. Since it is impossible to predict the market, we don’t try. History has also taught us that the best strategy is to invest all the money right away. Why? Because the longer your money is invested = the more you benefit from compound growth. So when your money is on the sidelines you miss out on this growth. Even worse, inflation decreases the value of the cash sitting in your bank account each year.
Note: this is best for long-term money, as it will be subject to short-term fluctuations in the stock market.
2) Invest in fixed income before equities
Both fixed income and equity investments have their place in your investment portfolio (below). Of the two, fixed income strategies are less volatile than equity investments. This means that fixed income strategies provide more short-term security. As such, we can invest our fixed income portfolio faster than equities (lower risk of losing money).
This provides psychological benefits beyond dollars and cents. As most client’s portfolios were much smaller before the lump-sum. Because a 10% drop in a $2,000,000 portfolio doesn’t feel the same as a 10% drop in a $20,000,000 portfolio. When the money is still new to the client, large swings like this cause panic and stress.
The last thing we want is for our clients to sell out of panic. To prevent this, we implement our Bomb Shelter Investing Strategy. This is a strategy that enables clients to hedge against traditional stock markets by having a portion of this portfolio not correlated to the stock market and this investment cannot decrease in value with stock market declines. This acts two-fold: they can protect the value of their lump-sum and sleep well at night.
After fixed income, we set aside a regular amount to invest in equities. This strategy is called dollar-cost averaging. Investors use this strategy to take advantage of the long-term price swings in the market. As in some months, the market will be ‘expensive’ (up) and sometimes it will be ‘cheap’ (down). Consistency allows us to average out the price we are paying over the long-term.
How to Get Started
Receiving a cash lump-sum should bring joy; not stress. Yet many lottery winners go broke from reckless spending, bad investments, poor advice, or a combination of all three. But this doesn’t need to be the case. At Elementus Wealth, we have advised countless entrepreneurs on managing a cash lump-sum. So if you have recently sold (or planning to sell) your business, please give us a call. We would be happy to chat.