Updated on 05.22.07

Did You Receive An Unexpected Windfall? Here’s Where To Put The Money

Trent Hamm

A recent article in Money lists 43 ways to deal with an unexpected windfall – in the article’s case, a $5,000 windfall. There are a lot of good suggestions in the article that make a lot of sense to me, like paying off your highest-interest credit card debt or investing for the long term with the T. Rowe Retirement 2045 mutual fund or a Vanguard fund mix.

The only problem with such an article is that it overwhelms you with options. I went through the article and eliminated everything that didn’t apply to my situation and that still left me with roughly thirty options to choose from, and that’s if you only limit yourself to the choices from the article. How can you quickly evaluate and narrow potential options for a windfall?

Here’s the thought process that I would follow if a windfall fell on my lap.

First, do I have an emergency fund? I’ve written about emergency funds before, and I think it’s very prudent to have two months’ worth of salary for every dependent on your taxes in a savings account. For us, that means six months – and soon, eight months, and I’d like to eventually have more than that just to be secure. As an absolute bare minimum, you should have $1,000.

Second, do I have any high interest debt that’s outstanding? This also involves considering the deductibility of such debt – if you have a house loan at 6% but are in the 28% tax bracket, that means your true rate there is about 4.5%, decidedly not high interest. I use 7.5% or so as my “line” between high interest and acceptable interest, but others may find this line to be higher than that. I have no debts that are high interest, so if I got to this step, I’d keep on going.

Third, what are my biggest goals? If you close your eyes and ask yourself what you’d most like to do with the money in the future, what comes up? Try to think beyond a few months so that you’re not tempted to do something like buy a monstrous flat panel television. Do you see a wonderful vacation in a year? Do you see a house in five years? Do you dream of retiring at age 50? Each of those options tells you a different thing you should be doing with your money. Figure out what your most important goal is, determine how far off that goal is, and look for investment goals in that timeframe.

If I were to get a $5,000 windfall today, it would likely go entirely into an emergency fund, which would bring it close to a level that I want. I’d use any leftover money to work on my investment portfolio that’s geared towards building our dream home in fifteen years or so, or possibly towards a car fund that’s about three years off.

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  1. I like the 7.5% cutoff. However if I have a windfall, I will simply hide it (invest it towards long therm net worth) and ignore the fact that I had a windfall. Out of sight, it will keep working for me.

  2. alex says:

    Wow, 7.5% interest seems high to me to consider acceptable. I have a 7% (nondeductible) student loan & an 8% (tax adjusted 5.36%) second mortgage which I am trying to pay off.

    While the long-term rate of return on the market is higher, paying off these loans reduces my monthly bills, thus reducing the amount of money needed for a low-interest emergency fund. It also allows me greater career freedom to take a lower paying, less stressful job. Also, unlike the market it is a guaranteed return without any of the risk of market fluctuation.

  3. Jess says:

    My husband and I don’t have any high interest debt, and have an adequate emergency fund (6 months) and a pretty well rounded investment portfolio. We keep track of what we are saving towards in a spreadsheet that has a list of things we’re saving towards with goals for each category (Vacations, House Downpayment, Future Children, New Car, New Mountain Bikes, etc.)

    Every month, we sit down together and allocate the interest earned the previous month and any additional money we’re putting in the account that month into the categories – it really helps motivate us to save more and spend less on frivolous things – because there are tangible goals at the end of the tunnel, and it is fun to see the money add up in the different categories over time. If we get a windfall – we just use the same process.

  4. Andamom says:

    I read the article — and wasn’t too impressed with their suggestions nor the layout of the article. I’d like a flow-chart like a game board… Come to think of it, I think I’ll work on one… “The path to financial independence” … or maybe that already exists in the game of Life.

    Seriously, there are some right versus wrong answers here — although the specific path that an individual should follow will depend on his or her circumstances.

  5. UncleOxidant says:

    I’ve got six month emergency fund (based on living expenses, not income). Recently, I’ve become concerned that the dollar is going to continue to drop in buying power and against other currencies. So I put about 1/3 of the emergency fund into FXY – an ETF trust that buys Japanese Yen (FXY). This _seems_ pretty safe as the JP Yen is considered undervalued at this point. What do others think about this as a way to hold value in your emergency fund? It seems pretty liquid and it’s based on a pretty solid currency, so it doesn’t seem like it would lose a lot of value. Is this prudent? Thoughts?

  6. Rick says:

    I would love to have a $5000 windfall… but alas, I am not that lucky.

    Uncle Oxidant: My opinion is that an emergency fund should be in virtually risk-free investments, such as a savings account. If you invest in the Yen, the market may act unexpectedly, and you may lose your investment. But if you invest in a savings account or a CD, your savings are insured by the FDIC (up to $100K). Besides, the chance of a bank going defunct is much lower than the chance of aberrations in the market causing you to lose your investments.

    Further, I can’t see a drop in the dollar against other currencies affecting you much on a practical level. You (fixed rate) mortgage remains the same, no matte what the dollar does. Buying stapes like soap, shampoo, food, etc., many of which are made in the USA anyway, won’t be affected that much (fuel for your car, on the other hand…)

    Just my thoughts. I’m no expert or anything…

  7. UncleOxidant says:

    Rick: I’m thinking that buying yen (through an ETF in this case) is pretty close to risk free at this point. It’s a currency so it’s value won’t go to 0. It’s also considered to be undervalued at this point (interest rates in Japan are 0.5%) and there is pressure from other members of the G8 for them to raise interest rates (which would lead to a more valuable yen) before the Yen carry-trade gets further out of hand. Certainly there is some downside risk, but I think it’s less than 10% at this point.

    The falling dollar is already effecting us on many levels – especially effecting how much we’re going to be paying for gas.

  8. Rick says:

    I guess my point is that I wouldn’t store my emergency fund in Yen. If you feel that yen is a good investment (and I agree that the yen is undervalued right now), than go for it, but I would invest my regular investment money in that, rather than my emergency fund.

  9. Ted Valentine says:

    UncleOxidant – let us know how that works out. This may be a way for the credit card arbitrage folks to double their efforts and squeeze out another couple pennies.

    Seriously – read the intro to this book here: http://www.harcourtbooks.com/bookcatalogs/bookpage.asp?isbn=0156029634&option=excerpt

  10. Lisa says:

    I am expecting a small inheritance of $7500 in the next 5 weeks. I was looking forward to putting it into my emergency fund. It would put me up to 5 months of emergency fund. Yeah!

    So what happens? My air conditioning/heating system stop working. Murphy’s Law in action. Oh well, the good news is I am only responsible for 50% of the repair/replacement and this what an emergency fund is for. I just wish the money had made it into the account first, just for a little while.

  11. UncleOxidant says:

    Rick: no way would I want it all in yen. Actually, I overstated it: I didn’t put 1/3 in yen, it’s more like 18%. The Emergency fund grew this past month more than I realized – now it’s actually more than six months worth ;-) 82% in $USD, 18% in yen – seems pretty safe – obviously if I run into an emergency the $USD part is immediately available.

  12. If I had a $5000 windfall, I would pay off some credit cards. My second option would be to add more money to an emergency fund. Lastly, I’d fully fund a Roth IRA.

  13. deRuiter says:

    #12 Dy, If you did option #1 on your list and paid off $5,000. worth of credit card debt, you could then take the money you’d been using to pay that credit card debt each month, and put it into a ROTH IRA. Pay the amount you’d have given the credit card company each month for a year into the ROTH, and you would have a fine return on your investment, and $5,000 less debt. Get a ROTH where you can add money monthly, up to your maximum donation. This way you would get “double” use out of your $5,000. windfall! Then you can direct the money in the ROTH into whatever investment you wish, having interest free income mount up in the account. If you buy stock in your ROTH (TD Ameriatrade is a sound place for a ROTH, banks do not offer so many options, and a ROTH at TD is free, no annual service charge, only a modest charge for actual stock tyransactions. This only works well if you stop running up balances on your credit card! That $5,000. less debt on the credit card is not a sign you can charge more. PS. Consider any money you spend as an investment, some just have a better return than others, and some investments return nothing, some even put you further in the hole.

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