Your 4-step plan for what to do with an inheritance

Received a lump sum of money? Here’s what you should consider doing with it.

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Those lucky enough to receive a lump sum of money, perhaps as a result of an inheritance, must then work out what to do with all that cash.

Although your ability to take the following steps will depend on just how much money you’ve been handed, I think there are a few actions that most of us should consider.

1. Pay off debts

Rather than squander the cash on shiny new things, I’d start by addressing any lingering debts. These could be in the form of a personal loan or anything on a credit card.

The latter should definitely be considered a priority since rates of interest charged by card issuers are usually high (an APR of around 20% is the norm). This means that those only making the minimum payments each month could be paying back a huge amount of money over the long term, even if what they originally purchased wasn’t all that expensive.

Tackling your debts first might sound dull but it’s good for both your financial and personal health. 

2. Pay off your mortgage

Having cut the high-interest debt, your next option might be to wipe out your mortgage (assuming you have one). Whether this is a good idea or not will be based on your circumstances and for how long you think interest rates are likely to remain at historic lows.

Another thing worth considering is whether your lender will charge for paying off your mortgage entirely. In such a situation, it may be best to overpay a little every month and reduce the amount of interest you’re charged over the term instead.

If in doubt, consult a financial adviser. 

3. Save a little

Here at the Fool, we think people tend to focus too much on saving (if they save at all) and too little on actually making their money work for them. The former might help you sleep at night but with inflation gradually eroding the value of your cash the longer it sits in your account, that’s a heavy price to pay.  

There is, however, a caveat to this. Having a little money to fall back on in times of trouble is perfectly sensible and should help cushion the blow from, say, a temporary period of unemployment. Having opened the savings account with the best interest rate you can find, the only question you need to answer is how much is enough.

4. Invest a lot

Here’s where things get interesting. Yes, it’s time to hit the stock market, especially if you’ve got no need for the money for at least five years.

The market may have a reputation for being a scary place but don’t let that put you off. One relatively low-risk option is to invest the majority of your lump sum into cheap exchange-traded funds that simply track the market return rather than trying to beat it. Many also pay dividends that can then be re-invested (recommended) or spent. 

Importantly, try to hold as many investments as you can in a Stocks and Shares ISA or a Self-Invested Personal Pension. When combined, these accounts allow you to deposit up to £60,000 in a single tax year. And if you’ve received anything over this amount, think about transferring some of your new-found wealth into similar accounts for your partner, children, or other family members.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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