How to invest a windfall: a beginner's guide
Whether it's an inheritance, a redundancy payment or even a lottery win, receiving a windfall can transform your financial circumstances.
But, unless you have already earmarked it for something, a lump sum may also require a slightly different approach as far as investment is concerned.
STEP ONE: PICKING AN INVESTMENT PRODUCT
First, think about where you would like to invest the money. Although there are plenty of different forms of investment, the length of time before you want to access the money, and how you'll want it, will play a major part in your choice.
For example, if you would like to save the money for your retirement, the tax breaks available on pension investment might make this a suitable destination for your investment. But if you need the money before you reach age 55, other types of investment will be more appropriate.
The level of risk you're happy to take will also shape your decision. Although it's possible to alter the amount of risk you take by holding different assets - for example an emerging markets fund is regarded as higher risk than a fixed interest fund - the characteristics of some investment products will expose you to higher levels of risk.
For instance, the fledgling company investment objective of many venture capital trusts (VCTs) means they are relatively high-risk, but you could also ratchet up the risk by investing in the shares of just one or two companies, leaving you at the mercy of their fortunes.
Also consider how much time you're prepared to spend on your investments. Investments such as exchange traded funds or index trackers offer you instant diversification and the security that they're performing as well as the market - for better or worse.
Other investments will require you to pay regular attention to how they're performing, revising your portfolio when necessary.
Read more: What should I invest in?
STEP TWO: YOUR INVESTMENT STRATEGY
Creating a well-diversified portfolio will help you manage risk and achieve the returns you expect. To create this diversification and build a portfolio that suits your risk appetite, spread your money across different asset classes, including equities, property, fixed interest (such as government and corporate bonds) and cash.
Each of these asset classes has its own characteristics that determine factors such as performance and the level of risk.
For example, with the four main asset classes, equities are regarded as the most volatile and therefore the riskiest of the main asset classes, followed in order by property, fixed interest and cash.
There are also differences in the level of income you can expect from these different asset classes.
While you can select shares that deliver a healthy stream of dividend income as well as capital growth, fixed interest investments, and to a lesser degree property, are focused primarily on producing a regular and predictable income.
STEP THREE: ASSET ALLOCATION
While all portfolios should have a mix of different asset classes, how you design your portfolio will be dependent on your appetite for risk and income. For example, if you are comfortable with taking risk and have a reasonably long timeframe or you're not dependent on the money, you could hold as much as 80-100 per cent in equities.
Conversely, if you were cautious, more of your portfolio should be in investment-grade bonds and cash with your equity allocation potentially down to 20 per cent or less.
Where immediate income rather than a growing capital (which can boost income in the future) is important, you might look to increase your fixed interest and property holdings, going for a greater weighting in high-yield bonds over investment-grade bonds if you were happy to take more risk.
It's also important to note that even within an asset class there can be huge variations in risk. As a rule of thumb, the smaller the company and the further away from the UK, for instance emerging markets, the riskier it is.
However, there are always exceptions to this as the near collapse of some of the UK's high street banks in 2008 demonstrates.
Your decisions should also be affected by any existing investments you might have. For example, if you already have a well-structured portfolio in place, you might want to stick with the existing asset allocation and top each element up.
On the other hand, and depending on how much risk you're prepared to take, you might want to add a new form of investment to spice up your portfolio.
STEP FOUR: TAX ISSUES
Although factors such as access to your money and risk profile should be more important in your choice of investment, consider the tax implications too. Making your money as tax-efficient as possible can help to boost the return you receive.
For example, for every £80 you pay into your pension, you'll receive £20 of tax relief from the government, effectively snagging you an instant 25 per cent uplift in your investment as well as giving you tax-free income and gains (contributions are capped at £40,000 or 100 per cent of your salary, whichever is smaller).
An individual savings account (Isa) will also help to shelter your money from the taxman; payouts can be taken at any time and are tax-free. VCTs are also very tax-efficient with the opportunity to secure an income tax rebate as well as tax-free growth and gains.
It's also important to cast an eye forward to when you might want to access your investment as this can have tax implications too. Capital gains tax (CGT) was reduced in the 2016 Budget and is now payable at the rate of 10 or 20 per cent, depending on your taxable income, on any profits you make in excess of the annual allowance (£11,000 in 2016/17).
Although you can take advantage of a spouse's CGT allowance as well as your own, think about when you're likely to need the money and be prepared to stagger taking it to avoid a huge tax bill. Alternatively, take advantage of some of the investments - Isas, pensions and VCTs - that have CGT exemptions.
While it may seem a long way off, you may also want to consider future inheritance tax implications, especially as this could effectively wipe 40 per cent off the value of your investment.
Pensions can work well as a means of passing on money to the next generation. If you are under 75 when you die, the person inheriting your pension pot will pay no tax on it. If you're over 75, they pay income tax at their marginal rate on any income or lump sums (from 6 April 2016) taken from it.
Using all or some of your windfall to set up a trust could stop you increasing the value of your estate without losing control of the money.
As another option, where you've received an inheritance, you could consider a deed of variation to alter the deceased's will, bypassing your own estate and going straight into someone else's, such as a child or grandchild.
We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.