Wednesday, May 18, 2016

What I'd Do With a Million Dollars (or any other amount)

Frankly I'm impressed it took me this long to use a stock photo of hundred-dollah-billllz

Everyone thinks they know what they would do with a windfall, but if it's actually staring you in the face, it's a daunting responsibility (I imagine). The pressure to make sure you don't blow it. The scariness of actually putting a large amount at risk in the market, or kissing it goodbye and sending it off the loan people. And how much of it can or should you use for fun? Any? It's always easier to be smart with hypothetical money than actual money.

Well, I do not have a windfall at the moment, so for me, it is hypothetical and therefore fun. That's why I'm going to tell you what I would, hypothetically, do with any amount of money in my easy-for-you-to-say armchair analysis. Maybe this will help guide me if I ever do find myself in this position.

Before Anything Else

I think I have these steps pretty much locked down for now, but should I backslide, I'd want to take care of these first, completely, and in this order:

Immediate Priority 1: Pay off any high-interest debts

I define this as any debt with an interest rate over about 7%. The conventional wisdom is that the stock market returns 7% on average in the long term, so it should be mathematically better to invest in the stock market than to pay off low interest debts. Of course, short-term results may vary. If the stock market has a bad year, maybe it would have been better to pay off low-interest debts the prior year. You just can't know until it's already over.

Croissant and I finished paying off all our student loans not long ago, but that would definitely have fallen into this category. Except for rotating credit card balances, which we pay off monthly, we currently don't have any of this type of debt. Yay! However, our looming medical issues mean this slot could be taken up with medical bills at any time.

Immediate Priority 2: Top up emergency fund

It makes me nervous not to have money in the bank "just in case". Currently, we are trying to keep 5 months of barebones expenses (i.e. just needs and bills, not discretionary fun money). This money is set aside in its own category in the budget, and we don't double-count it toward our other goals. The idea is that we have something to carry us through if we are laid off, or wind up in the emergency room, or our boiler breaks or something. This is great because we don't need to go into debt or scramble and scrounge for money in these cases: it is just right there. After using part of it, we try to pay it back ASAP, putting other goals on hold.

Beyond Immediate Priorities

Elizabeth Warren is my co-pilot, and in her book All Your Worth, in addition to breaking down your budget by percentages (at most 50% to needs, at most 30% to wants, at least 20% to savings), she further suggests how that 20% to savings should be broken down: 10% to long-term retirement savings (e.g. your 401(k)), 5% to overpay your mortgage (if you have one), and the remaining 5% to Dreams and Goals. I feel like I can apply that general strategy for any savings windfall.

Once my immediate priorities were taking care of, I'd split any remaining money between medium and long term goals.

Medium-Term Dreams & Goals (50%)

Currently, my wife and I are saving for medical stuff, but the Current Most Important Savings Goal changes over the years. We have also used this goal slot for things like home repairs, a down payment, travel, wedding stuff… I like having one major goal at a time for the satisfaction of completing it. Windfall money could be directed to the savings goal until it's full, then to the next (if there are several).

However, I'd only set aside half of the windfall, at most, to topping up current dream funds, because I'd also want to give some love to my long-term goal.

Long-Term Goal: Retirement (50%)

I'm so jazzed about retirement that I can see this basically becoming my medium-term dream/goal if I run out of other things. So far I haven't, but you never know. In that case, deciding what to do with a windfall would be real easy, because I'd direct it all onto the retirement pile.

But how? Saving for retirement can be tricky with a windfall, because typical retirement vehicles assume slow, even saving over many years.

You can throw a lump sum into an IRA, but I'm on track to max my IRA for the year anyway, so maxing it all at once would just free up the money I set aside each month for my IRA for the rest of the year. Which is nice, don't get me wrong, and they say the best time to enter the market is always now. But it might be simpler to just leave my auto-payments to my IRA alone and use the windfall for whatever I would have used the monthly extra for.

You can't throw a lump sum directly into a 401(k). It has to be taken out as a percentage of your paycheck. But I could try the more elaborate strategy of increasing my 401(k) percentage, then setting aside the actual windfall money in a special budget category to dole out paycheck replacement. Money is fungible, after all. This is a trickier maneuver to pull off without accidentally overspending the money or feeling weird about "living on savings." I'd also need to make sure to set my contributions back to the way they were before, and to do it several weeks before the money runs out, since it sometimes takes time for changes to go through. I probably wouldn't bother to deal with all this.

If nothing else I could always throw the money into a taxable brokerage account and invest it in the same broad, whole-market index funds that I favor in my retirement accounts. This is the simplest approach, but it would leave tax savings on the table.

What About Overpaying the Mortgage?
I definitely haven't been putting one-quarter of my existing savings toward this, despite Elizabeth Warren's recommendation. I guess I'd be further along on my mortgage if I did, but since I'm thinking about going back to renting, it seems like a bad time to start.

The point of this recommendation, I believe, is a long-term investment in the future. It's just one that is both lower-risk and lower-return than investing. It's guaranteed that you get a 3% return on your investment if your mortgage interest is 3%.

If I decide to be a homeowner for the long haul, I should definitely start doing this with any windfalls and even my month-to-month savings. If I go back to renting, I'll just redirect this portion to long-term retirement.

What makes me feel good about this roadmap is that it applies no matter how big or small the windfall is. I can apply it to any size giant lump of money that chooses to rain down on me. (A girl can dream.) I can also apply it just as well to the littler dribs and drabs that I pull out of my monthly budget.

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