Money Matters

Advice for investing an inheritance wisely

October 13, 2012 

Q. I will receive a large sum of money around Dec. 1 from an inheritance. I have been told that most of this will be cash with a few stocks, bonds and mutual funds. I’m pretty young (late 20s) and would like to invest the money aggressively in growth mutual funds. I want to have a plan in place so I can invest immediately upon receipt of the money. I don’t have much experience investing, but I do know that I want to avoid high sales charges and fees, so I’m interested in learning about no-load mutual funds. Are there any educational tools you would recommend for a novice investor? Any advice you have for me?

Since an inheritance is the result of someone’s death, I offer my condolences.

My advice, which may seem self-serving, would be to meet with a knowledgeable fee-only financial adviser. In addition to helping you develop a portfolio and selecting specific investments, he or she can review your overall financial situation. A review may reveal some important uses for some of your inheritance in addition to investments.

Questions such as the following should be answered before you decide how much and where to invest:

• Do you have adequate disability/life insurance?

• Do you have adequate liability coverage?

• Should you invest in a Roth or a traditional IRA?

• Should you increase your contributions to your employer-sponsored retirement plan, and use some of your inheritance to make up for the resulting reduced cash flow?

• Are there current debts or future major expenses that should be addressed before investing?

• Do you need to set aside any money for college?

• Is your estate plan up-to-date?

Even though you are young, investing aggressively may not be the right choice. If you begin with $100,000 and lose 30 percent that first year, it will take almost four years with a 10 percent rate of return just to get your account back to $100,000. If you continue to achieve a 10 percent rate of return for the next five years, your account will be worth a little more than $160,000. If you only lost 10 percent in year one of investing, you would attain the same account balance with a 6.6 percent rate of return over the next nine years. The classic children’s fable “The Tortoise and the Hare” teaches that slow and steady can win the race; this philosophy can also apply to investing.

Be cautious when buying mutual funds at the end of the year. Mutual funds are required to pass on profits from selling stock and bond holdings to their shareholders.

These profits are called capital gain distributions. Mutual fund investors are taxed each year on a fund’s distribution if they are invested in the fund as of the “record date.” The distributions are taxable whether you have held shares in the fund for a week or a year, and whether you reinvest them or take them as cash. The only exception is if the fund is held in a tax-sheltered account such as an IRA.

You should avoid buying prior to the distribution or “record” date to minimize tax liability.

Call the mutual fund companies you are considering, and ask for the record date of the specific fund in which you plan to invest. Buy the fund after the record date, and you will not receive these taxable distributions. A large number of funds pay out capital gains in August and September, but most wait until late November or December.

An index mutual fund or an exchange-traded fund will have fewer distributions than an actively managed fund.

Clark Howard has some great educational information on his website, clarkhoward.com. “Investing 101” by Kathy Kristof also is worth a look. It sells for less than $10, and you also can download it for free from some websites.

Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 99466, Raleigh, NC 27624

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