Prudent Ways to Handle a Sudden Financial Windfall

By John Persinos
October 15, 2010

Windfalls come in many forms: inheritance, bonus, legal settlement... or maybe you just won the lottery. When you receive a financial windfall, you need to decide what to do with the money.

People are often confused about how to handle newfound riches. Family and friends will inundate you with unsolicited advice; taking their suggestions to heart typically is a bad idea. Money has a way of clouding the judgment of those around you.

Here's some advice to help you keep a cool head before the fresh dough burns a hole in your pocket:

Pay off your credit cards! Now!

Seems obvious, right? Unfortunately, getting rid of high-interest debt often is an individual's last choice with a windfall. Instead, they start ogling shiny new cars in the dealer showroom. Reducing the balance on your Visa, MasterCard and Discover card to zero should be your No. 1 priority. Also pay off any consumer loans.

Avoid the common trap of paying off credit cards and consumer loans only to run-up fresh balances. It's a vicious circle.

Seek a temporary safe haven in short-term investments.

After you've eliminated credit card and other high-interest debt, park what's left in a safe haven. Don't feel pressured to immediately put the money into riskier investments. Take your time. Put it into a Certificate of Deposit (CD) or Treasury bill. Before you make a specific decision among the three alternatives, compare interest rates and term lengths so that you can get the most bang for you buck over a time period you're comfortable with.

If you're looking for a CD, be sure to shop around. Compare offerings from local banks and credit unions, which compete to offer the most attractive CDs. Also check with your broker and do some homework on the Internet, where you can easily find lists of high-yielding CDs.

As for Treasury bills, here's a tip that many people don't know: You can save money by acquiring T-bills directly at no cost from the U.S. Treasury, thereby circumventing intermediaries such as a brokerage firm or bank that would charge you a fee. Visit www.savingsbonds.gov for more information and application forms for actually buying T-bills online.

Maximize your retirement plan contributions.

If you haven’t been able to invest fully every year into your Individual Retirement Account (IRA) or 401(k) plan, now is your opportunity to do so. It's important for your long-term financial health that you invest in your future security (while you simultaneously enjoy tax deferrals and savings).

Pay down your mortgage.

Consider making extra payments against your home mortgage, which would greatly enhance your retirement situation. If you have a home equity loan, consider paying it down -- or paying it off.

Make sensible home improvements.

Consider applying some of the money to long-deferred fixes and improvements to your home. However, be sure to make the right kind of home improvements. Not all building projects reap an investment return; homeowners tend to subscribe to many myths about how to increase their home value.

[InvestingAnswers Feature: How to Increase the Value of Your Home]

Buy yourself a toy!

Yes, you read it right: If you've followed all of the steps above and you still have some money leftover, splurge and treat yourself to something nice (within reason). Maybe you need a new suit, flatscreen TV or stereo speakers.

A wise investor is a happy investor. You'll make better decisions in the future if you're able to enjoy at least some of your money today. You want to be prudent, not Puritanical.