Q & A: How should I use an inheritance? Invest?

June 6th, 2007

In this scenario the person involved has $40,000 in student debts at an interest rate of 8.5% and currently rents an apartment. The person inherited $400,000 (after tax) and is unsure what to do with it.

Suggestion: Considering the individual in question does not own a home it is probably a good time to look at buying a place so that rent money isn’t being thrown into the wind each month. Even if $250,000 is spent on a home, there is still $150k left. Buying a home is safe. It prevents the individual from having to make monthly mortgage payments for the next 30 years. This lowers the cost of living considerably and takes a lot of stress off during hard times. If the economy crashes, at least the roof over this individuals head is safe. Only food and utilities would be needed.

The debt of $40,000 should be paid off with this money. If this money was invested there is a chance it could do better than 8.5% or it could do worse. It could even lose money and have a negative return. By paying off the 8.5% loans it is the equivalent to getting a gauranteed return of 8.5%. Nothing wrong with getting a gauranteed return like that!

This leaves $110,000 to invest. If this money is able to get a compound rate of return of about 10% over the next 40 years it could still turn into millions. The individual can even add to the investment account each month with the money that would have gone towards the mortgage. If $1,000 is put away each month into the investment account, it will grow to be:

• $1.4 million in 20 years
• $3.9 million in 30 years
• $10.3 million in 40 years

If the interest rate is higher than 10%, like 12%, then instead of $10.3 million in 40 years it would be almost double!

In this scenario the individual has a house that is paid off, no debt and a growing retirement. Safe and sound! When someone passes on and leaves an inheritance it is nice for them to know all the money will not be lost in some stock crash or bad investment. They know the money actual helped.
Many investment advisors would suggest that the individual get a mortgage for most of the house since interest rates are usually low. The reason this isn’t the best idea has to do with the chance of rising interest rates, bad investments, the chance of losing a job due to a poor economy, a falling US dollar, potential wars in the future, etc. A long term approach is safer against some of the pitfalls that can occur, and may help protect the family’s wealth from being completely wiped out.

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