For most of our adult lives, if we’re lucky, our finances are predictable. We get paid once or twice each month. We pay our rent and utilities every month. If we’re lucky, we have a bit extra left over to put aside for the future.
But every once in a while something exciting happens. Without much warning, a large sum drops onto our laps. Maybe we’ve sold a house or been given a small inheritance. A clerk or solicitor hands us a fancy-looking cheque and we can’t believe such a small rectangle can represent so much money. It’s exciting but also scary. What do we do with this money? And what if we mess it up?
So many articles are written about how to handle a lump sum. But this one’s special, you see, because I have a lump sum right now. I sold my house last month, and my family will be renting for a while. My profits are sitting in my current account. What should I do now? What are my options?
If I wanted, I could do nothing. I could leave all those pounds in my current account. But there are two big problems with this plan. I don’t know about you, but I can’t really trust myself. If all my money sat in an account that I used every day, I’d eventually start spending it down, bit by bit. At the same time, I’d be losing money to inflation. We all know that prices tend to go up over time – that’s inflation. If I let the money sit in an account where it isn’t growing, it’s almost guaranteed to lose purchasing power. Would there ever be a reason to pick this option? Only if I knew I’d be spending the money very quickly, like if I were buying another house.
A Savings Account
At most banks, I could easily transfer my pounds from a current account into a fixed savings account. This would lock my money away for a period of time – say one or two years – but I’d be paid for my trouble. Rates are always changing, but the longer the term, the more interest I’m likely to earn. This would at least keep me running pace with inflation (https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/january2019) , and after the term was up I could take out my money if I needed it. If I found an account that paid 2% a year, for example, I’d make £1,000 after a year. Much better than the practically 0 I’d make in a current account.
Since this article is about my money, this option doesn’t apply, because I already max out my ISA each year. But if I didn’t, it would make sense for me to open up, or top up, a Cash ISA. This would be similar to a fixed savings account, but I wouldn’t have to pay any taxes on the gains.
Invest the money
If I really wanted to give my money the potential to grow, I would open an investment account and put the money into shares. Now, I wouldn’t pick the shares myself. More likely I would invest in a tracker fund, which would spread my investment across a large number of shares found in an index such as the FTSE 100. Then I’d be buying a bit of every company in the FTSE 100. Over the long term, one of these funds is likely to outperform a regular savings account.
But if this is true, then why wouldn’t everyone invest the money? Why do savings accounts exist at all? Well, notice I said investments are better than savings accounts “over the long term”. In the short term, investments can drop, and drop hard. This is called volatility. It means that my £50,000 could drop down to £25,000 in a bad year. What if I need the money? I’d have to cash out, and that would make my losses permanent.
A good rule of thumb, which I use, is that I only invest money if I won’t need it for at least 5 years. And as with savings accounts, an ISA is best (if you haven’t maxed yours our yet).
So those are some options, but what am I actually going to do?
See, my wife and I don’t know if we’ll like renting. In a year, we may want to try to buy another home. So we couldn’t stomach a 50% drop if we invested our money and got unlucky. So we’re going with a fixed savings account. The money will stay locked up for a year and we’ll make a bit of money. From there, we can choose to spend it, invest it, or lock it up for another year.
Is this the right answer? I don’t know. The truth is that until we can predict the future there can’t be a right answer. The best we can do is pick a plan that works with our life situation.
Photo - Colin Watts