If you’ve received a cash lump sum, it can be hard to know what to do with it. Investors today have a wide range of options and choosing the right option is important, as your decisions could have a significant impact on your future finances. Here, we are going to discuss the best investments for a cash lump sum. Whether you have received a pay-out from your employer, inherited a windfall, disposed of a property, or sold your business, this is how to go about investing your capital.
What are your goals?
When choosing the best investment for a cash a lump sum, the first step is always to determine your financial goals. Here, it’s useful to ask yourself two key questions. First, what does your life look like today? And second, what do you want it to look like in the future?
At this stage of the process, it’s also important to establish your risk tolerance. Here, you should consider both your willingness to take on risk and your capacity to take on risk. The two things aren’t necessarily the same.
When determining your goals and risk tolerance, it can pay to think about your liquidity, lifestyle, and legacy requirements. Focusing on these three concepts can help you determine the best investment for your cash lump sum.
Failure to plan adequately for liquidity requirements may force you to sell your investments at the wrong time, so it’s important to assess your short- to medium-term cash flow needs before investing your money.
Once you have considered your liquidity needs, you can focus on your lifestyle and think about investing your money to meet your life goals. Everyone’s goals are different and yours may include paying for children’s school or university fees, travelling the world, or retiring in comfort.
After this, consider your legacy. Would you like to pass on wealth to future generations? If the answer to this question is yes, it’s a good idea to put a plan in place early.
Developing an investment strategy for your cash lump sum
Once you have established your goals and risk tolerance, it’s time to develop an investment strategy for your cash lump sum.
A good strategy will include a range of different assets including:
● Stocks and shares: Stocks and shares have historically generated the strongest returns for investors over the long term, however, they are higher-risk assets.
● Bonds: Bonds are less volatile than stocks but offer more modest returns.
● Alternative investments: Alternatives, which include commodities, real estate, and private equity, are higher risk but can help diversify an investment portfolio.
● Cash and cash equivalents: These are the safest investments but offer the lowest returns and provide no hedge against inflation.
By spreading your capital across the different asset classes, you can lower your investment risk.
The investment mix, or ‘asset allocation’ you choose will be important. It could impact your ability to meet your financial goals. For example, if you don’t have enough exposure to growth assets in your portfolio, your cash lump sum may not earn the appropriate returns over time to meet your goals. On the other hand, if you take on too much risk, the money for your goals may not be there when you need it. So, familiarising yourself with the risks associated with the different types of assets is important here.
Given the importance of selecting the right asset allocation, you may want to consult a financial professional for advice on the best investment for your cash lump sum at this stage of the process.
Investing your cash lump sum tax-efficiently
You will also want to give some thought to the best type of investment account for your lump sum. Tax can be a major drag on your wealth over time so it’s important to seek out tax-efficient accounts and other ways to reduce tax for high income earners.
In the UK, one of the most tax-efficient ways to invest is through a pension. Within a pension, all capital gains and income from your investments are tax-free. Additionally, contributions come with tax relief meaning that they can significantly lower your Income Tax bill.
For the 2023/2024 tax year, the standard annual pension contribution allowance for tax relief purposes is 100% of your salary or £60,000, whichever is lower. However, if your lump sum exceeds your allowance, you may be able to take advantage of pension ‘carry forward’ rules. These allow you to make use of any annual pension allowance that you have not used in the last three years. Alternatively, you may be able to make contributions on behalf of your spouse, who will have their own annual pension allowance.
It’s worth pointing out, however, that when you invest in a pension your money is locked away until retirement age (currently 55 but rising to 57 in 2028). So, a pension is not the best investment for a cash lump sum if capital is needed in the short term.
For those seeking more flexibility in terms of access to capital, investing within a Stocks and Shares ISA can be a good option. Within these accounts, capital gains, dividend income, and interest are tax-free. However, unlike a pension, money can be accessed at any time. Currently, every adult in the UK has an annual ISA allowance of £20,000. This means that a couple could potentially save £40,000 per year into two ISAs, sheltering a substantial amount of money from HMRC. You can also consider funding Junior ISAs for children up to their annual allowance of £9,000 until they reach the age of 18.
Consider a venture capital investment for your cash lump sum
If you have already used up your annual pension and ISA allowances, and you are comfortable taking on a higher level of investment risk, you may want to consider venture capital schemes. These schemes, which have been set up by the UK government, offer very generous tax breaks and so could be the best investment option for a cash lump sum.
Investments can be made into either a Venture Capital Trust (VCT) or Enterprise Investment Scheme (EIS). VCTs are quoted companies on the stock exchange and investment into them qualifies for a 30% income tax break at point of investment. They also provide investors with tax-free dividends over the duration of the investment with a minimum qualifying period of five years. The quoted nature of these investments allows them to be traded at any time, although if done so before the qualifying period expires, all tax relief will be lost. On realisation of the investment, no Capital Gains Tax (CGT) is payable, and the proceeds can be recycled into a new investment to receive a full set of tax concessions.
The Enterprise Investment Scheme has been designed to promote investment into small, early-stage companies that aren’t listed on a stock exchange. The EIS currently offers a range of tax breaks, including Income Tax relief of 30% on investments up to £1 million per tax year, no Capital Gains Tax (CGT) on gains realised on the disposal of EIS investments (provided the investments are held for three years), CGT deferrals if proceeds are invested in qualifying EIS investments, and Inheritance Tax (IHT) relief if investments are held for two years.
These venture capital schemes are higher-risk investments, however. So, it’s a good idea to speak to a financial adviser before deciding if this is the best investment for your cash lump sum.
Timing your investment
Once you’ve established the best investment for your cash lump sum, you need to decide whether you will invest it all at once or stagger the investment over time. While investing a lump sum all at once will give you maximum exposure to the markets, it will also increase the risk of investing a large amount of money at the top of the market. Investing your capital over time can reduce this risk and potentially help you lower the average price paid for your investments.
Gradual investments can also be smart from a tax-efficiency point of view. By spreading your investment out over multiple tax years, you may be able to invest more money tax-free. For example, over two tax years, a couple could potentially invest £320,000 in their pensions and ISAs tax-free.
An adviser can help choose the best investment for your cash lump sum
Given the importance of getting things right, it’s a good idea to consult a financial adviser before investing a lump sum. A financial adviser can guide you through your investment options and advise you on the best course of action for your individual circumstances.
To find out more about how we can help you determine the best investment for your cash lump sum, contact us here , or call us on 01275 462 469.
- Bowmore Financial Planning Ltd and Bowmore Asset Management Ltd are authorised and regulated by the Financial Conduct Authority
- Bowmore Financial Planning Ltd and Bowmore Asset Management Ltd are not regulated to provide tax advice
- The value of your investments can go down as well as up, so you could get back less than you invested
- The tax treatment of certain products depends on the individual circumstances of each client and may be subject to change in future
- Past performance is not a guide to future performance
- A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.