What to Do with a Windfall with Markets at All-Time Highs

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“I’ve just received a large sum of money. Is now a good time to invest?” That is one of the most common questions I receive from clients.

Determining the optimal approach for investing a large pool of cash is always challenging. The fact that markets are trading near all-time highs can further exacerbate this predicament.

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The concern of buying high and the potential for the market to have a change in fortune at the drop of a hat, as we experienced last year, is very real. Below are points to consider to help investors implement a prudent strategy in today’s volatile market environment.

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1. Market timing

Don’t try it! Some investors may flirt with the idea of waiting for the bottom of the next bear market to invest their money. In theory, waiting for stocks to drop by 20% in order to buy everything on the cheap seems like a great idea. In practice, however, 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.

Now that we understand why timing the market is the wrong approach, let’s explore some practical strategies for deploying cash at market highs.

2. Diversification

Choosing to have exposure to a variety of asset classes is always imperative. This principle applies to any investor’s specific situation. While the U.S, market has been setting record highs as recently as mid-February, many other areas of the global market have not had such a good run. For example, European and emerging market equities have had relatively underwhelming returns over the past decade. These markets may experience a reversion to the mean, making their returns much more attractive than they have been over the past 10 years. Maintaining a diversified strategy when deploying capital can minimize volatility, balancing assets that were bought high with other sectors that are relatively low.

3. Long Time Horizon

Dollar-cost averaging is a perfect strategy to make sure an individual is saving and investing money on a regular basis. However, the market’s long-term trend is positive. Therefore, the best course of action for an investor who doesn’t need the assets for a long period of time may be to invest the lump sum all at once. They will buy at lower average prices now and may outperform someone who is slowly adding money over time. If you have a multi-decade time horizon, and your specific risk tolerance doesn’t indicate otherwise, then consider putting all the money to work right away.

4. Approaching Retirement

Folks who are retired or who will be retiring shortly need to be the most careful with their investment strategy. Getting caught in a major market downturn right before you stop working 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 much longer than originally planned.

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One way to invest that manages for sequence of returns risk is to set up a “bond tent.” The concept of a bond tent is to keep a few years’ worth of expense money in very short-term high-quality bonds or cash. The remaining assets can be invested, perhaps more aggressively, according to their various other goals. Should the market have several years of subpar returns, the investor won’t have to liquidate their more volatile holdings 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.

5. 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 in a similar allocation to the current portfolio. It is a relatively small sum of money, and stressing over how to invest it won’t necessarily change your current or future lifestyle.

The scenario where the lump sum represents 25% or more of total savings has more factors to contemplate. As a start, considering the source of the new assets may help provide guidance on how to deploy them.

Pension or 401(k): If the assets are from a pension or 401(k) plan that have accumulated over decades with one employer, chances are that you’ve accumulated a meaningful sum of money. This money was probably invested in stocks and bonds prior to being liquidated to move to an IRA or another 401(k) plan. As such, the money should immediately be reinvested into the appropriate allocation based on the client’s age, time frame and risk tolerance. There is no benefit in delaying putting this cash back into the market.
Inheritance: In the scenario where the money was inherited, the specific needs of the client will play an important role in determining next steps. Do they have enough cash on hand? Are there major short-term expenses on the horizon? If the investor does not need this need cash in the immediate future, a strategy that includes a combination of investing a large portion of the money immediately and dollar-cost-averaging the rest over time to meet the investor’s needs make sense. This hybrid approach can be a great way to allow the client to benefit immediately from dividend and interest payments on the lump-sum investment while still protecting the client’s new assets during a market downturn.
Sale of a business: If the money consists of proceeds from the sale of a business, it’s important to evaluate several factors. Depending on the circumstances, a multipronged approach, where different portfolios are set up depending on various goals, may make the most sense. If the sale is right before the client’s retirement, refer to the section above on “approaching retirement.” If, on the other hand, the investor is young and planning to start future businesses, they may require a certain level of liquidity. In a legacy planning scenario, putting a large sum of the assets to work right away may be prudent.

If the investor is unsure of what’s to come, it’s important to avoid sitting paralyzed in cash while contemplating your next move. That paralysis would have the negative consequences of losing buying power with inflation and missing out on compound interest to meet the investor’s financial objectives. Since this money 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. It may be worth implementing the hybrid approach described above for an inheritance. That will allow the money to grow or generate cash flow for the investor, while also providing a cushion of liquidity should their next endeavor require it.

Making the right decision on how to prudently manage a large windfall can seem overwhelming. Take the opportunity to touch base with your tax, legal and financial advisers 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. One of the most important aspects of financial planning is reassessing and tweaking your plan as your circumstances change.

Receiving a large sum of money, or any other major life-changing event, is the perfect time to make sure you are still on track to achieve your objectives.

Disclaimer

Disclaimer: This article authored by Jonathan Shenkman a financial adviser at Oppenheimer & Co. Inc. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Oppenheimer & Co. Inc. does not provide legal or tax advice. Opinions expressed are not intended to be a forecast of future events, a guarantee of future results, and investment advice.

Disclaimer

Dollar-cost averaging does not guarantee a profit and does not protect against loss in declining markets. Investors should consider their ability to continue making purchases through periods of fluctuating prices.

Disclaimer

Global diversification does not guarantee a profit nor protect against a loss.

Disclaimer

The Standard & Poor’s (S&P) 500 Index is an unmanaged index that tracks the performance of 500 widely held, large-capitalization U.S. stocks. Individuals cannot invest directly in an index. Adtrax #: 3455229.1

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Jonathan I. Shenkman, AIF®, is the President and Chief Investment Officer of ParkBridge Wealth Management and serves as a financial adviser and portfolio manager for his clients. In this role, he acts in a fiduciary capacity to help his clients achieve their financial goals.