Economically, the key question to ask on a lump sum versus a stream of payments is what you would have to earn to replicate the stream of payments. Most of the time, the stream is worth more than the lump sum, so don’t take the lump sum.
The second question is more important. Can you be disciplined and not waste the lump sum? Ask those close to you what your money habits are like, if you don’t know for sure. Ask them to be brutally honest.
Investing the Lump Sum
Again, one nice thing about taking payments, is that you don’t have to invest the lump sum. If you do take the lump sum:
- First, pay off high interest rate debts.
- Second, avoid buying big things and calling them investments. Don’t buy a big house when you don’t need a big one.
- Third, don’t invest in any of your relatives’ or friends’ business ventures. Tell them you try to keep personal affection and money separate. It avoids hurt feelings.
- Fourth, look at the time horizon of your real needs. Plan for retirement, college, etc. Invest accordingly — get a trustworthy adviser who will help you. Trustworthiness is the most important factor here, with competence a close second.
- Fifth, don’t so it yourself, unless you have developed the skill to do it previously. If you want to do it yourself, you will have to gauge whether the various markets are rich or cheap in order to decide where to invest. For some general, non-tailored advice, you can look at articles in my asset allocation category. As an aside, don’t invest in anything unusual unless you are an expert.
Receiving Spending Money from Your Investment Fund
The first thing is to decide on a spending rule: many use a rule that says you can take 4% of the assets from the fund. My rule is a little more complex, but will keep you safer, and adapt to changing conditions: as a percentage of assets, take 1% more than the yield on the 10-year Treasury Note, or 7% if less. At present, that percentage would be 2.21% + 1% = 3.21%.
Whatever rule you use, be disciplined about your spending. Don’t bend your spending rule for any trivial reasons. Size your budget to reflect your income from your investment fund and all of your other income sources.
Conclusion
Remember that most people who get a lump sum end up wasting a lot of it. The only thing that can keep you from a similar fate would be discipline. If you don’t have discipline, don’t take a lump sum. Take the payments over time. That will give you the maximum benefit from what is a very valuable asset.