How to invest a lump sum ?

I’ve just had a windfall gain land in my bank account.

What is a windfall gain?

What do I mean by a windfall? I think of it has a material, lumpy sum of money that arrived somewhat unexpectedly.  Many of us can expected windfalls at some point in our lives, but they remain unexpected in amount and timing. Some are happy events – winning a lottery.  Probably more are the silver lining on a sad cloud – such as inheritance, compensation payments, etc.

This particular windfall is because a company that I ‘angel invested’ in a few years ago has just been acquired.  The company has done well and my shares have grown in value a lot – over 10-fold.  I’ve been forced, by the investment transaction, to sell my shares.  Thanks to the generous UK tax breaks for angel investors, this large gain is subsidised by the taxman.  My gain is almost completely tax free.

These shares were in a private UK company, so they were extremely illiquid.  I don’t treat such investments as part of my tracked investment portfolio – I treat such ‘angel’ investments as ‘flushing money down the drain’ and thus truly consider any gains I eventually receive as money from heaven.   I usually can’t choose to sell, can’t choose what price to take, and often have very little information about the business – in this case, a lot less information than the acquirer. Indeed in this particular case a portion of my money has been retained in an escrow account for 12 months pending ‘warranty claims’ by the buyer, so I don’t even have all my money yet.

In any case, in this particular situation I am in the happy position of a six figure sum landing serendipitously in my bank account.  This sum isn’t enough to change my life – in fact it is a smaller sum than the decrease in my portfolio’s value in the first three months of 2018 – but it is a much larger amount of cash than I normally have at hand.  What to do with such a sum?

The perils of good fortune

Academics will tell you we are more likely to spend windfalls than other equivalent sums.  I remember a long time ago, when I first made some serious money and had a life-changing windfall to celebrate, how a friend of mine was pushing me to buy an Aston Martin.  His psychology was, and is, very different from mine. But even I have found over the years that if you aren’t careful some of your ‘easy come’ money does ‘easily go’, and you can forget some of your (e.g. tax) liabilities, and the next thing you know your good fortune has become a painful cash shortage.

The only personal bankrupt I know was a high flying star in his forties, a few years ago.  But he was a Spender, not a Saver, and he is far less financially literate than his considerable intelligence would suggest.  He forgot about the tax man, and it only took a few months before flying high was replaced with humiliating bankruptcy.

My windfall management system

So, from prior experience I now have something of a system for handling unexpected windfalls.

• First of all, I need to understand the tax liability I now face.  In this case I owe around £10k; this is a sum I would normally find out of cash flow, so I can almost ignore it. And I won’t need to pay the bill until January 2020, which does seem some way away.  However for the purposes of this discussion I am going to ‘put the tax money to one side’.  Back in the day when interest rates were 5%+, one could make a useful sum of interest out of Her Majesty Government’s money in the 9-18 months before it was due, but these days that is harder.  These days I do however have a clear use for such ‘borrowed’ cash – I use it to pay down my margin loan.  My £10k tax liability is, for now, reducing my interest payments – which is equivalent to it earning a taxable 4.5% interest.
• Secondly, I think of charity.  I link most of my charitable activities to my angel investing.  Especially where I have benefited from angel tax breaks, I try to give 5-10% of my windfall to charity.  I try to do this as fast as possible.  Ideally, you have given the money away before you have quite got used to the new bank balance in your account.  In this case, I have made three donations (large enough to be handled by the ‘Major Gifts’ team, I notice) and promised a fourth.
• Thirdly, I think of any house keeping I need to do.  In this particular case I made a slightly rash (and poorly documented, alas) promise to somebody involved in the angel business to give him a sum ‘if I made money out of this investment’.  A more practical bit of house cleaning might be to update the will – for instance after the bereavement of an intended beneficiary. I have set aside the sum to do this ‘house keeping’, and will follow up on this shortly.  In the meantime, this sum can temporarily reduce my margin loan and thus ‘earn’ 4.5% p.a.
• Fourthly, I budget myself ‘a treat‘.  Not quite an Aston Martin, but it is nice to splurge a little – even more so if you can tell yourself ‘I bought that art/car/clothing/holiday thanks to my investment in X’.  I am budgeting about £10k of ‘treat’, and Mrs FvL has quite co-incidentally made a couple of proposals for this money almost immediately.
• Finally, I start investing the remaining funds.  For me this means allocating the funds against my target investment exposure. I am making a £100k+ reduction in my margin loan.  And of course lump sums are good ones to shift into tax-efficient places, so I have topped up Mrs FvL’s pension, and moved a disproportionate amount of the funds into Mrs FvL’s unwrapped broking account, and I may top up my Ltd company.  I’ll keep some money on hand (i.e. temporarily additional debt reduction) to do more angel investing with, and put the rest to work in my existing broking accounts.

There are at least 10 payments/transfers to make here.  As a practical matter, I build myself a little financial To Do list of each transaction, which adds up to the total windfall, and I tick each item off as I do it.  So far I’m about half way through it, and should be sorted by the end of the month.  Then my money will be back to work, in its proper place.