How to invest a lump sum

Receiving a large lump sum of money can be both exhilarating and overwhelming, particularly if you've never had significant savings or capital to manage before.

Whether it's an inheritance, redundancy payment, bonus, property sale proceeds or even lottery winnings, the decisions you make in the weeks and months following receipt can significantly impact your financial future.

While this guide can help walk you through the essential considerations and practical steps for investing a lump sum wisely, this is not financial advice. It's a good starting point, but it often makes sense to seek professional guidance from an FCA-registered independent financial advisor, particularly for larger sums or complex circumstances.

Before you start investing

The temptation to immediately invest or spend a windfall can be strong, but patience typically pays dividends. The first rule of receiving a lump sum is simple: do nothing immediately.

Park the money in an easy access savings account for at least a month, preferably around three to six months. This cooling-off period allows the emotional intensity of receiving the money to subside, can prevent you from making impulsive decisions you might regret and gives you time to educate yourself and seek appropriate guidance.

During this waiting period, it can be a good idea to keep the receipt of the lump sum private. Well-meaning friends and family members often have strong opinions about what you should do with your money, but their circumstances, risk tolerance and financial knowledge will differ from yours.

Unsolicited advice, however well-intentioned, can cloud your judgment. Similarly, be wary of investing into unresearched assets as fast as you can. Investing will still be available after your cooling-off period.

Use this time to assess your complete financial picture. Create a comprehensive spreadsheet listing all your assets, debts, income sources and regular expenses. This financial audit will form the

foundation for all subsequent decisions, because you can’t make informed investment choices without knowing where you currently stand.

Consider your emotional relationship with money. Has receiving this lump sum changed how you feel about spending or saving? Are you experiencing anxiety about making the wrong choice? Understanding your psychological state will help you to recognise when emotions might be driving decisions that should be made rationally.

Finally, resist lifestyle inflation. Just because you have more money doesn't mean you need to immediately upgrade your home, car or daily spending.

Many lottery winners and inheritance recipients find themselves in worse financial positions years later precisely because they allowed their lifestyle to expand to match their windfall rather than maintaining their previous spending levels while investing the difference. Of course, there’s a balance to be had here.

Clearing the decks

Before considering investments that might generate returns, address anything that might be costing you money.

High-interest debt should be your first target. Credit card debt, personal loans and payday loans typically charge interest rates that far exceed any realistic investment return. If you're paying 20% interest on a credit card balance, paying it off immediately delivers a guaranteed 20% return, something no investment can promise.

For example, imagine you have £5,000 in credit card debt at 20% interest and £10,000 to invest. If you invest the full £10,000 and achieve a respectable 7% annual return, you'll earn £700 in the first year.

However, that £5,000 of debt will cost you £1,000 in interest over the same period, leaving you £300 worse off despite making a good investment. Clear the debt first, and you're immediately better off.

However, not all debt demands immediate repayment:

• Mortgages — often charge low interest rates which might reasonably be maintained if you believe you can achieve higher returns through investment, particularly when factoring in tax advantages on certain investments
• Student loans —often work more like a graduate tax than traditional debt, with repayments tied to income rather than the outstanding balance, making early repayment often inefficient from a purely financial perspective. The debt is sometimes wiped as well
• Car loans and other medium interest debts — require individual assessment based on their interest rates compared to realistic investment returns, though paying them off eliminates both the interest cost and the monthly payment obligation

Of course, these scenarios will all depend on your personal financial situation. The point is to conduct the analysis so that you’re confident you’re making the right decisions.

Beyond debt, it can make sense to ensure you have adequate protection in place:

• Life insurance — crucial if others depend on your income, ensuring your family can maintain their standard of living if you die prematurely
• Critical illness cover — protects against the financial impact of serious health conditions, providing a lump sum if you're diagnosed with conditions like cancer, heart attack or stroke
• Income protection insurance replaces a portion of your salary if you're unable to work due to illness or injury

It’s also useful to build an emergency fund covering three to six months of essential expenses before making any significant investment. This cash might sit in an easy access account earning modest interest; while leaving money in cash when you could be investing it might feel like missing out, this fund serves as a buffer that prevents you from needing to sell investments during market downturns.

For example, if you get hit with a vet bill, boiler breakdown or job loss you can cover the costs from your emergency fund rather than selling shares.

Understanding your goals

Next, start by listing your financial goals with specific timelines. Are you saving for a house deposit you'll need in three years? Building a fund for your children's university fees in fifteen years? Supplementing your pension for retirement in thirty years?

Each of these goals has different time horizons, which fundamentally influence how you should invest.

The relationship between time horizon and investment risk is one of the most important concepts in personal finance. Investments in shares and stocks can be volatile in the short term; while it can feel scary, a diversified stock portfolio might lose as much as 30% of its value in a bad year. However, over longer periods, these same investments have historically delivered significant returns.

So if you need your money in two years, it’s possible you can’t afford this volatility. If you won't need it for twenty years, you can ride out the inevitable fluctuations and benefit from the long term growth potential.

Consider not just when you'll need the money but how you'll use it. Will you need the entire lump sum at once, or will you draw it down gradually? Someone investing for retirement might plan to withdraw a sustainable amount annually for thirty years of retirement, which is quite different from someone saving for a specific purchase who needs the full amount at a particular time.

Your goals should also account for inflation. Money sitting in a low-interest account might feel safe, but if inflation runs higher than the interest offered in a savings account, you’ll lose real purchasing power over time.

It’s also important to be realistic about returns. You’ll often see this phrase or something similar: Past performance isn’t a guarantee of future results. Just because one fund or theme delivered handsomely one year, it doesn’t mean it will every year.

A balanced portfolio might reasonably target perhaps 5-7% in annual returns over long periods after fees and inflation, but these returns won't be smooth. Some years will be negative, others exceptional. Higher return investments are available, but the risk is commensurate to the reward.

Risk management

Understanding your relationship with investment risk requires considering both your practical capacity for loss and your emotional tolerance for volatility. These are distinct concepts that sometimes conflict.

Your capacity for loss relates to your financial circumstances. Someone with a secure job, no dependents, a paid-off mortgage and adequate pension provision can afford to take more investment risk with a lump sum than someone in precarious employment supporting a family with significant ongoing financial commitments.

For example, if losing 30% of your investment would meaningfully impact your ability to meet essential goals or maintain your standard of living, your capacity for loss is limited regardless of your emotional comfort with risk.

Risk tolerance, by contrast, is often psychological. How would you actually feel and behave if your investment fell significantly in value? Many people believe they have high risk tolerance during bull markets when everything is rising, only to discover they cannot stomach the stress when markets inevitably decline.

There's no shame in having a lower risk tolerance; the worst outcome is misunderstanding your tolerance and panic selling during a downturn, crystallising losses that might have recovered given time.

Consider your past behavior with money and other stresses. Have you previously made rash decisions under pressure? Do you check your bank balance compulsively? Do financial concerns keep you awake at night? If you do, you might struggle with the volatility of higher-risk investments, regardless of whether such investments suit your financial circumstances.

Risk tolerance also changes with time horizon. The same person might appropriately take substantial risk with money they won't need for 25 years while taking minimal risk with money needed in three years. This is why people typically shift their pension investments toward lower risk assets as they approach retirement, because their time horizon for recovery from potential losses shrinks.

Different investment types carry different risk profiles. For example:

• Cash savings — have minimal risk of capital loss but significant inflation risk over time
• Government bonds — those from stable countries are very secure but offer modest returns that may barely outpace inflation
• Shares — can be highly volatile, with potential for substantial gains or losses
• Property investments — can be illiquid and concentrated, exposing you to local market conditions
• Alternative investments — including commodities can be extremely unpredictable with dramatic price swings

Diversification reduces risk without necessarily reducing returns. Rather than investing your entire lump sum in a single company's shares or a single property, you might spread your money across multiple asset classes, geographical regions and sectors means that poor performance in one area can be offset by better performance elsewhere.

This is where ETF investing can come in handy; allowing you to invest in a basket of securities in one trade.

Tax efficient investing

The UK tax system provides several account types designed to encourage saving and investing.

Individual Savings Accounts (ISAs) are the cornerstone of tax efficient investing for most people. Money invested within an ISA grows completely free of tax on dividends and capital gains (price growth) on profits when you sell. Your allowance is £20,000 per tax year, which runs from 6 April to 5 April the following year.

For lump sum investing, the Stocks and Shares ISA arguably offers the most flexibility and growth potential. You can invest in funds, individual shares, bonds and other securities within the ISA wrapper, and all returns remain tax free. If your lump sum exceeds the annual ISA allowance, you'll need to develop a multi-year strategy to move money into ISAs progressively, keeping the remainder in a taxable investment account or high-interest savings account in the meantime.

Pensions represent another highly tax efficient structure, particularly for higher earners. Contributions to SIPPs receive tax relief at your marginal rate, meaning a higher rate taxpayer only needs to contribute £60 from their pocket for every £100 entering their pension. Money within pensions grows free of capital gains and income tax. The trade-off is reduced accessibility; you cannot normally access pension funds until age 55, rising to 57 from 2028.

Outside tax-advantaged accounts, understanding capital gains tax and dividend tax becomes important. Each individual has an annual capital gains tax allowance, currently £3,000, meaning you can generate this amount of profit each year tax-free.

You can learn more about ISAs and SIPPs with us.

Capital allocation

With your preparation complete and tax efficient structures understood, you then face the question of what to actually invest in. The investment universe can be intimidating, but for most people investing a lump sum, a relatively straightforward approach involves using index funds and exchange-traded funds (ETFs).

These products have revolutionised personal investing because rather than attempting to pick individual winning companies or paying expensive fund managers to do so, they simply track market indices like the FTSE 100 or S&P 500 with minimal fees.

A globally diversified equity portfolio might include UK equities, developed international markets like the US and Europe, and emerging markets. This geographical diversification means your investment isn't overly dependent on any single economy's performance.

Bonds provide stability and income within a portfolio. Government bonds from countries like the UK, US and Germany are extremely secure but offer modest returns, while corporate bonds pay more interest but carry more risk. Bond allocation typically increases as you approach your goal date, reducing volatility when you can least afford it.

A young person investing for retirement in 40 years might hold 90% equities and 10% bonds, accepting short-term volatility in exchange for long-term growth. Someone five years from retirement might shift to prefer bonds, prioritising capital preservation over maximum growth.

You might also consider property through real estate investment trusts, which provide property exposure without the complications of direct ownership. REITs trade on stock exchanges like shares but invest in property portfolios, providing diversification and liquidity that direct property cannot match.

For many people, a simple three-fund portfolio covering global equities, bonds and perhaps some property exposure or gold provides adequate diversification without unnecessary complexity.

Lump sum or drip feeding?

One of the most difficult questions is whether to invest a lump sum immediately or drip feed it into the market over time, a strategy called pound-cost averaging. Both approaches have their merits depending on your circumstances and psychology.

The mathematical case for immediate lump sum investment is straightforward. Markets trend upward over time, meaning any delay in investing represents time out of the market when you could have been benefiting from growth.

However, if the markets falls after you invest, drip-feeding means you can continue to invest at lower prices, reducing your average cost. This is the appeal of pound-cost averaging; by investing fixed amounts at regular intervals, you automatically buy more when prices are low and less when prices are high, smoothing your entry price.

The real advantage of drip-feeding is psychological rather than financial.

Investing a large sum immediately means you'll see the full impact of any market decline, which can be emotionally challenging. If you invest £50,000 today and the market falls by 10% next month, you're suddenly £5,000 poorer on paper. For many people, this is unbearable, potentially leading to panic selling at the worst possible time.

Drip feeding over six or twelve months means any market decline affects only the portion already invested, making it emotionally easier to stay the course.

Consider your emotional response to market volatility honestly. If investing everything immediately would cause you significant stress or tempt you to sell during a downturn, drip feeding might be worthwhile despite potentially sacrificing some returns.

The best investment strategy is the one you can actually stick with through market cycles.

A hybrid approach offers compromise. You could invest a significant portion immediately, gaining immediate market exposure while keeping some powder dry to invest if markets decline. This captures much of the upside of immediate investment while providing psychological comfort and the practical ability to benefit from any downturn.

Lump sum investing summed up

• Consider a cooling off period of three to six months before making any major investment decisions to avoid impulsive choices driven by emotion
• Prioritise clearing high interest debt like credit cards first, as paying off 20% interest delivers a guaranteed return
• Use tax efficient structures like ISAs (£20,000 annual allowance) and pensions to maximise your returns by avoiding capital gains and dividend taxes
• Consider your time horizon carefully. Longer timelines allow for higher risk investments in equities, while shorter timelines require more conservative approaches