Your client has just received or inherited a lump sum of cash. Maybe it came from a rollover retirement account, maybe they sold some assets, or it was an inheritance. They are not sure what to do—but keep their first inclinations at bay…it’s likely that their first thoughts are to spend it. But, this could be a perfect time to invest it.
One of the first things your client needs to take into consideration is whether to invest their proceeds all at once, or over a period of time using dollar-cost averaging (DCA). This strategy helps clients invest equal parts based on preplanned intervals. Here are four simple questions to ask your client to help them decide on which strategy may be right for them:
What is your client’s savings situation?
A good rule of thumb is 20%. If a lump sum is 20% or less of the amount your client has already saved, then investing the entire amount into existing asset allocation may be the best course of action. But if the lump sum exceeds 20% you can ask…
Was this received from an employer pension plan?
If so, then the cash was most likely only recently invested in stock and bond investments. This means that it’s probably best to invest it right back into the same sort of allocation. If your client’s 401(k) were recently invested in stock and bond funds, then it should be reinvested into a stock and bond allocation that’s appropriate for the client’s needs. This is a good time to take a look at asset allocation and distribution and explain to the client where they stand for the big-picture.
Was the money from the sale of a business or property?
If yes, then the money was previously attached to a business risk, even if it wasn’t direct stock market risk. In this case, advisors should consider investing a portion of this money into an allocation of stocks and bonds based on the client’s needs and DCA the remaining assets over a period, possibly a couple of years. This will help spread out the entry-point risk of getting into the markets. If the timeframe and risk tolerance permit staying the course through volatile markets, then the client can put the entire amount to work for them as quickly as possible—giving it more time to earn the market’s expected long-term returns.
Was this money inherited, won, or from another source without previous ownership?
Here’s another place that DCA can work well for many clients. Financial advisers may find it important to suggest that clients consider investing portions of the funds now and spread the rest over a DCA plan of a few years. This again helps negate the entry-point risk a bit.
When a client receives a lump-sum cash distribution, it may present an opportunity for both of you. This can serve as a good time to take a refreshed look at your client’s financial goals and dreams, and fine tune the strategy you take towards their investing and estate planning accordingly. These points can help get your client started on the right foot.