Difficult talks about a pleasurable finance topic (Part 1)

November 18th, 2008 · No Comments

We recently received a relatively large, lump sum, cash amount from a life insurance payout.  This gave us the the “opportunity” to argue about what to do with it, plus the “fun” of struggling our way through some different priorities.  Should we pay off the second mortgage?   What about that auto loan?   How much, if any, should we invest and should it be via a lump sum or dollar cost averaging?   Should we look into angel investing or even buying a business?  Is it just us or is talking about money matters always difficult?

I guess it comes down to “analysis paralysis” for us.   We both know there are many wise things we could do with the six-figure amount of cash we received.   The trouble is in figuring out which ones are “best”.  While I think we’re both pretty rational (well, sometimes I question that my wife is 🙂 ), we have different opinions about priorities, and thus different definitions of “best”.   This makes it difficult to actually do something with the money.

Looking back on it, I’d say that the most important decision to make in this admittedly rare situation is to figure out where to park the money until real decisions can be made on what to do with it.   In fact, I’d highly recommend that every family agree in advance on where any unexpected cash income should be parked, and if possible, have the necessary channels and accounts already established.  We had not done this and thus our money sat in a low-interest-rate checking account for too long while we happily debated what to do with it.  Eventually, we realized we wouldn’t reach any long-term decisions for quite a while and that’s when we started to focus on the short term location for it.  Turns out we lost about $10/day for a couple weeks by not putting it in a 3% yield savings account immediately.

I’m definitely not saying everyone should be prepared to handle a large life insurance payout at all times.  I am saying that having a plan for handling any income outside of normal salary cash flow will help maximize how well your money works for you.  Clearly, the larger the amount the more important this is, and also the more likely you’ll have a delay in figuring out how to put it to real use.  But the principal remains the same even if we’re only talking about money you found laying around on the street.  Get it working for you by paying the maximum yield as soon as you can.

Anyway, I believe the important factors to consider when deciding where to park your money are, in order, liquidity and then yield.  I say this because, by definition, we’re talking about a temporary location here.   When you do come to a decision on how to really use the money, that use is likely to result in an effective yield that is significantly higher than anything you could get on any short term parking account.  This means you’ll want to move the money instantly and thus liquidity is very important.  You’d only worry about maximizing yield once you’ve identified the amount of liquidity you’ll need.

We have now balanced the liquidity-with-yield requirement by opening an Electric Orange checking account at ING Direct to go along side of our high-yield savings account there.  This works because transfers from their savings to checking are instantaneous, and it is much easier to distribute money from a checking account than it is a savings account.  Besides, with any high-yield savings account you’re likely limited to only 6 outgoing transactions per statement period so it is much better to transfer a single large amount to the checking and split it up from there to go different places.  This preserves the maximum number of future withdrawl options for your savings account.

Since this post has gotten alot longer than I expected just by talking about temporarily parking the money, I’ll leave the discussion of our decisions to a follow-up post.

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Tags: Passive Income · Personal Finance

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