If you find yourself in the fortunate position of landing a windfall and you choose to invest it, you want to make sure you put your money to work effectively.
Here are three questions to ask yourself before deciding where to invest a lump sum.
What Are My Investment Goals?
The first question is whether you want to grow your money or generate an income from it. If growth is your goal, then you should be prepared to invest it for five years or longer. That way, your investment has time to recover if it falls in value.
Bear in mind, your goals will probably change when you retire- income becomes more important as it replaces your salary.
Am I Investing Tax-Efficiently?
The next thing you need to do is ensure you’re taking advantage of the various tax breaks available to investors.
One option is to pay into your pension and benefit from the tax relief the government pays on contributions.
However, you must stick to the annual allowance of £40,000 or 100% of your salary, whichever is lower. And if you’ve already started drawing your pension, this allowance drops to £10,000.
Alternatively, you could invest through a stocks and shares Individual Savings Account (ISA) which protects your returns from capital gains tax and income tax. The ISA allowance for the 2017/18 tax year is £20,000.
And finally, interest from bonds and investment funds (more on these below) counts towards your personal savings allowance (PSA) of £1,000 for basic rate taxpayers and £500 for higher rate taxpayers (additional rate taxpayers don’t get a PSA).
What Can I Invest My Lump Sum In?
What you invest in is typically guided by your investment goals.
If you want to grow your money you might invest in shares, although sometimes you can also earn income in the form of dividends.
Shares are among the riskiest investments as the price fluctuates according to the company’s fortunes, but they offer the greatest potential returns.
If income is your goal, you could try investing in bonds. Bonds are essentially loans to a government or company, which pay interest and return your investment at the end of the term.
Government bonds, known as gilts in the UK, are considered the least risky investment as a government is unlikely to default.
One way to manage risk is through diversification. This involves spreading your money across a range of different types of investments in various countries or regions.
If you don’t have the time or expertise to diversify your portfolio by yourself, you could try investing in a fund instead. A fund is a pooled investment which picks shares or bonds (or a mixture of both) on your behalf.
You should consider reducing the amount of risk you take as you approach retirement. So if you hold mostly shares in your portfolio, it may be worth shifting some of your money into less risky investments like bonds or income-generating funds.
Of course, the safest place to put your money is in a bank account. But with interest rates at record lows, inflation will eat into your savings.
However you decide to invest your lump sum, remember the value of your investment can fall as well as rise. There’s always a chance you may not get back the same amount you invest.
If you rely on investment returns to support you once you’ve retired, your standard of living could be affected.
- Before you invest, ask yourself whether your goal is to grow your money or generate income.
- Make sure you take advantage of the tax breaks available to investors.
- Tax-efficient accounts include ISAs and pensions, while returns in the form of interest count towards your PSA.
- Shares are a risky investment but offer greater potential returns than other types of investments.
- Bonds are essentially loans to governments or companies which pay interest and aim to return your money at the end of the term.
- Investing in funds can help you diversify your money across different types of investments in different parts of the world.
- As you approach retirement, consider reducing the amount of risk you take with your portfolio.
- With interest rates at record lows, inflation eats away at the value of your savings.
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