How to Allocate an Investment Windfall Using the Best Investments.

Yes, this is a good problem to have- receiving the profits from your investments, property sale, private equity allocation, or any type of windfall of cash that you may or may not have anticipated.


For most people, financial windfalls simply don't occur by chance. However, I believe you can do a few things to tip the scales in your favor: You must invest more money than you spend each month, which at the very least requires you to understand and manage your own spending. You must understand your risk tolerance, and create a portfolio allocation that factors in your specific risk scenario and financial objectives. You will need to take risks with your savings and investments. Lastly, you must be prepared for investment opportunities with available cash at hand when they occur. 


Plan Your Windfall

I believe it's important to have a plan for this type of incoming money well ahead of receiving it. 


Windfall Assumptions: 

-You have no consumer debt, student loan, automobile, or any other debt except for mortgage on your primary and smaller mortgages on your rentals or commercial properties- each mortgage fixed under 4%.

-This new money is not needed for expenses; it is basically new incoming cash at your disposal. 

-You are already invested the maximum amounts into your retirement accounts, IRA's, SEP's, etc.

-You have already allocated the appropriate tax savings for this windfall.


Risk Categories: 

Here are few risk categories and proposed allocations for the new money received: Note that this is just a proposed allocation with commentary and discussion points included based on my experience and discussions in the personal financial community- see disclaimer below regarding my financial advice qualifications.


(1) Super Conservative - You are concerned about your job, you're overleveraged on your mortgages, you aren't sure how much longer you want to work at building wealth- you are ready to just stop and live on what you have saved to date. You eagerly anticipate paying down your primary mortgage to zero, and you really enjoy seeing the principal balance get reduce in larger chunks. You aren't bothered by the lost opportunity cost of a 4% mortgage versus potential greater market gains. 


Super Conservative Allocation:

100% of the proceeds to go into your primary residence mortgage paydown.

0% of the proceeds to go into a 1,2,3,4 and 5-year CD ladder scenario. 

0% of the proceeds to go into S&P 500 index fund

0% of the proceeds go into individual high dividend paying stocks with a long-term expectation for growth.


(2) Medium Conservative - Your career and financial prospects are OK, but not great. Your mortgages still represent a significant amount of your money income pay and asset paybacks- You still want to work to create more wealth while balancing the plan to reduce your mortgage debts.


Medium Conservative Allocation:

80% of the proceeds to go into your mortgage paydown.

10% of the proceeds go into a 1,2,3,4 and 5-year CD ladder scenario. 

5% of the proceeds go into S&P 500 index fund with a long- term expectation for growth

5% of the proceeds go into individual high dividend paying stocks with a long-term expectation for growth.


(3) Medium Risky

Your career and financial prospects are OK and potentially growing. Your mortgages represent a medium amount of your income pay and asset paybacks- You are still driven to continue to work to build more wealth. Your mortgage debt is under control, and it does not cause you concern, but you enjoy seeing the mortgage principal reduction. You are comfortable with the bet you are making on US Equities and individual high yield dividend stocks vs paying down a 4% fixed rate loan.


Medium Risky Allocation:

40% of the proceeds to go into your mortgage paydown.

10% of the proceeds go into a 1,2,3,4 and 5-year CD ladder scenario. 

30% of the proceeds go into S&P 500 index fund with a long-term expectation for growth

20% of the proceeds go into individual high dividend paying stocks with a long-term expectation for growth.


(4) Higher Risky

Your career is great, and you accept the risks associated with the long term equity investments. You anticipate paying down the mortgage with the recent windfall plus index and private equity gains. You anticipate increasing your individual stock positions in the future. You like the equity opportunities more than paying down your mortgage today.


Higher Risky Allocation:

25% of the proceeds to go into your mortgage paydown.

5% of the proceeds go into a 1,2,3,4 and 5-year CD ladder scenario. 

40% of the proceeds go into S&P 500 index fund with a long-term expectation for growth

30% of the proceeds go into individual high dividend paying stocks with a long-term expectation for growth.


(5) Super Risky 

You've made one or two good off market equity or property investments, the mortgage paydown is already occurring with your current asset paybacks. Your work is interesting, and you are ready to see your expanded balance sheet with continued equity investment growth. You look forward to future private equity deals. You believe your 4% fixed rate loan in a great given the gains you've made elsewhere. 


Super Risky Allocation:

0% of the proceeds to go into your mortgage paydown.

0% of the proceeds go into a 1,2,3,4 and 5-year CD ladder scenario. 

10% of the proceeds go into S&P 500 index fund with a long-term expectation for growth

30% of the proceeds go into individual high dividend paying stocks with a long-term expectation for growth.

60% of the proceeds go into another high risk closed market venture/startup position. 


(6) Stupid (or genius) Risky

You've benefitted from multiple off market high risk scenarios in the past. Your mortgages are covered each month by other income, plus profits on the rentals. You enjoy working and never plan to stop. You enjoy the thrill of off market deals and you can absorb any private equity losses. You even anticipate a tax loss benefit if a loss occurs. You actually look forward to taking a loss to offset tax gains in other positions.


Stupid Risky Allocation:

0% of the proceeds to go into your mortgage paydown.

0% of the proceeds go into a 1,2,3,4 and 5-year CD ladder scenario. 

0% of the proceeds go into S&P 500 index fund with a long-term expectation for growth

0% of the proceeds go into individual high dividend paying stocks with a long-term expectation for growth.

100% of the proceeds go into another high risk closed market venture/startup position. 


Summary: 

As with asset allocation in your retirement, it may make sense to spread out windfall returns into multiple asset categories depending on your risk tolerance. From risk level (1) to risk level (6), you can benefit from paying down your mortgage in large or small amounts. Each level increases your net worth and risk, and each level can create a win. If more of your money goes to pay down your mortgage, then you benefit from the paydown immediately. If less of your money goes toward the mortgage paydown then more goes to other investments- And you are still potentially growing your net worth. I call each of these scenario's a win now, or win later benefit. 


I prefer to implement risk level (3) Medium Risky on a windfall in most cases. Let me know where you stand. Contact me at  money@financialsombrero.com 


Note that I am not a financial or legal professional, nor am I licensed to sell securities, or any other financial instruments. Given this statement, I strongly recommend that you consider this blog as entertainment value. Although, I sincerely hope that I can motivate you to learn to build your own financial knowledge and wealth.



Financial Sombrero



Building Wealth Knowledge Every Day