I have £X, what do I do with it – A step by step guide 3


One of the most common questions in the personal finance space goes something like this: ‘I have £X, what should I do with it?’. When people receive a lump sum in the form of a gift or inheritance, they usually don’t know what to do with it. This is because they have never been in a position of having that much money before and are afraid they might lose it.

This post aims to give a step by step guide for those looking on guidance on what to do with a lump sum receipt of money. The guidance below is general nature and you may have to tweak it to meet your own personal situation. If you have have any doubt talk to a professional such as a CFA

Step 1: Build an emergency fund

An emergency fund is a stash of money you have set aside for an emergency situation, such as unexpected unemployment or injury, or any other unexpected need for money.

Your emergency fund should have enough obey to cover 8 month worth of expenses. So if you spend £1000 a month, your emergency fund should ideally have £8000 in it. I have gone for 8 month instead of the usual 6 before jobs are much harder to get and the job hunt takes much longer than before. Besides, 8 month gives you added safety and you are not forced to accept the first job that comes your way.

Your emergency fund should be held in safe investments you can access quickly. Ideally you want to hold your emergency fund in a bank current account or an easy access cash ISA.
Having that cushion keeps you out of further debt in case of an emergency.

Step 2: Pay off your debt

Debt is the number one wealth killer. If you want to get rich and stay rich you should avoid any high interest debt. This means that you should pay off any debt before you even start thinking about investing money. Credit card debts carries interest of over 10%; you would be lucky to get this sort of return in the stack market. By paying off debt, you can be better placed financially as well have piece of mind.

The general notion is to use the entire lump sum to pay off any debts you have, bar the mortgage.

If your lump sum receipt is not sufficient to cover all your debts, you can at least get the ball rolling using the snowball method. The debt snowball effect is a method on how to pay off debt when you have multiple accounts in debt. The strategy is that you should begin paying off accounts that have the smallest balances first whilst only making minimal payments on the larger debts. Once the smallest debt is paid off, you should go on to pay off the next smallest debt. You should carry on this technique until all your debt is paid off.

Step 3: Work place pension

Once you have paid off all your debts, you need to ramp up the amount of money you put in to your employer-sponsored pension scheme especially if there is a matched contribution from your employer.

Now that you have more money as a result of your lump sum, you can contribute more towards your work place pension without you feeling the lower take home pay too much. The advantage of an employer pension scheme is that it is often ‘matched’, this means that your employer puts in ‘free money’ for your based on your contribution up to a certain limit.

For example, say your salary is currently £30,000 employer has a scheme that offers a match up to 5% of your salary. It would be to your benefit to maximise this ‘match’ amount. So if you pay 5% into your work place pension, your company would also match it by paying 5%. This means that instead of only £1500 going into your pension, £3000 is going in. The extra £1500 your employer pays is essentially ‘free money’. You are already 100% up on your investment! You can not find quick returns anywhere else like that so make sure you maximise your contribution to your employer sponsored pension scheme up to the match amount.



Step 4: Put a deposit down for a house.

This step is for those not already on the housing ladder. If you already own your own home, you can skip this step and move to the next one.

We all know that house prices keep skyrocketing here in the UK. It is becoming more and more harder for people to get on the housing ladder. The best thing you can do with your lump sum is to buy the house outright. The next best thing you can do is put money towards a deposit.

The good news is that with your lump sum, you can can put money towards a deposit.

Now just because you have enough money for a deposit does’t mean you should stretch your self when getting a house. Make sure you only buy a house where you are comfortable paying the monthly mortgage payment. The last thing you want to do is buy a house that is too expensive for you and fail to meet the monthly mortgage payments!

Step 5:  Learn about investing

The greatest way to build wealth is to learn how to invest. Two of the best asset classes to invest in are property and stocks.

In the UK, many people would prefer investing in property due to the ‘safety’ it provides over many other asset classes. Furthermore, you can use other people money by getting a buy to let mortgage in order to fund the purchase of a rental unit. But new changes which will be introduced in April 2016 will take some of the dazzle away from buy to let as there will no more be tax breaks on mortgage interest and there will be increased stamp duty for the purchase of a second home. So make sure you read into any legislative changes before you decide to invest in buy-to-let.

If you want to invest in property but don’t want the hassle of running it or want to avoid borrowing money to purchase a house, you can always invest via property crowdfunding. This is where ordinary people like you and I collectively put up money to buy a property and thus we are all owners of that property and we jointly receive any rent paid by tenants. Have a look at my reviews of TheHouseCrowd, Property Moose and Property Partner to find out more.

I prefer to use the stock market to build wealth. History has shown that stocks offer a better return than property in the long run. When it comes to investing in stocks, there are two competing schools of theory. Active investing and Passive investing. Active investors think they can beat the market whilst passive investors say that history has shown that it is impossible for the average person to beat the market.

What you choose is up to you. But here is a brief guideline of whether to chose active or passive investing.

  • Are you interested in investing?
  • Are you interested in understanding how business work?
  • Are you willing to learn accounting rules and read through the accounts and financial statements of the companies you invest in?

If you answer yes to the above, consider buying individual stocks that you have researched. If on the other hand you answered no, consider taking the passive approach. With passive investing, you simply buy a index fund which tracks the market. With an index fund you are essentially buying the whole market. So if you buy a FTSE100 index fund, you are essentially invested in the top 100 companies listed on the FTSE. So if you invest £1000 into a FTSE 100 index, you have essentially bought £61 of HSBC, £46 of British American Tobacco, £44 of GlaxoSmithKline and so on.

If you feel that investing in the stock market is right for you, move on to step 6.




Step 6 – Open up an ISA or a SIPP

In order to maximise your gains when you invest in stocks and shares, you need to invest using a tax shelter. The two most common tax shelters are an ISA and a SIPP.

  • Investment Saving Account (ISA) – You pay money into ISA after tax but the advantage is that any capital gains and dividends your ISA produces is tax free. You essentially pay no tax when you withdraw money from an ISA.
  • Self Invested Pension Plan (SIPP) – You pay money into a SIPP using before tax Pounds. Your SIPP provider normally collects this money for you, so if you put £100 into a SIPP, you will have £120 provided that you are basic rate taxpayer. Whilst you get the initial tax back when investing in a SIPP any money you withdraw is taxed at your personal income level.

You can open an ISA or SIPP to buy shares using any reputable online brokerage company. Read my guide to the best brokers and a step by step guide to buying stocks and shares in the UK.

Best brokers for passive investing:
If you have no interest, stick to index fund investing. Either use a roboadvisor like Nutmeg or Investyourway who do all the work for you. Alternatively, do it yourself by buying index funds. Use bogle heads.

best brokers for active investing:
If you want research companies and buy individual stocks, the best accounts to use are Hargreaves Lansdown for convenience, AJ Bell Youinvest for long term buy and hold investors or Degiro for cheapness.

 

Step 7 – Spend some money

If you still have some money after doing all the above, you can spend money on yourself without feeling guilty as you know your financial house is in order. Be frivolous and spend some money on yourself. This will have a long term benefit of keeping you motivated in being financially disciplined as you can get some gratuity now.

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