3 ways to invest a $50,000 windfall

(Money Magazine) -- Question: I'm 33 years old and seem to live paycheck to paycheck. I'll be coming into $50,000 soon, however, and I don't want to blow it. What's your advice on how I should invest this money once I have it? --Jay, Lowell, Mass.

Answer: I applaud your desire to properly invest your $50,000 windfall. It's great that you want to do the right thing with it.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

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But unless you find a way to stop lurching from one payday to the next, I fear that even the best investing strategy in the world isn't going to improve your long-term financial prospects very much.

Why?

Well, the fact that you don't mention having any savings already set aside plus your admission that you're living paycheck to paycheck suggests to me that you don't have your spending under control. Another way of saying that is that you spend whatever amount is available to you.

Up to now, that amount has been limited to your paycheck (unless, of course, you've also been borrowing). But once you have an extra 50 grand that's easily accessible, I suspect that the temptation to spend even more than you do now will be extremely hard to resist.

So absent a change in your spending habits, I think there's a good chance that sooner or later you will start dipping into your fifty large, and eventually eat your way through it.

Given that possibility, it's hard for me to recommend appropriate investments. Typically, a 33-year-old should have the vast majority of his investment stash in stock mutual funds. The rationale is that, even though equities can take a beating in the short-term, stocks typically provide the best opportunity to make your money grow over long time periods. And someone in his 30s will have his money invested a good 30 years or more, allowing plenty of time to bounce back from short-term setbacks.

But if there's a good chance that you'll be raiding your investments in the near term, then investing mostly in stocks makes less sense. If the market tanks while you're tapping your stash, you would be selling at the worst possible time.

All of which is to say that your investing strategy isn't something that takes place in a vacuum. It's got to fit with the way you live and handle your overall finances.

So if you want this windfall to have a real shot at improving your financial life over the long haul, I recommend you consider taking the following three steps:

1. Set aside a portion of your $50k as an emergency reserve. Basically, you want to have about six months' worth of living expenses in a money-market account, three- to six-month CDs or a money-market fund, so you have a stash of cash that is readily available but totally insulated from the financial markets' ups and downs. I want to be clear, though. This is an emergency fund. It's something you go to only when really necessary -- i.e., if you get laid off or run into a large unexpected expense you can't avoid and that you can't budget for out of regular income. It's not a personal Grant-a-Wish fund that you draw from every time you see something that might make life nicer but you can't afford given your earning power. The whole idea is give you a cushion to help you get through tough financial situations without having to go into debt and without having to liquidate your investments.

2. Invest the rest of your windfall in a conservative mix of stock and bond funds. Normally, I'd tell someone your age to invest 70% or more of his investment stash in stock mutual funds. But until you demonstrate that you really can invest for the long term, I think you ought to take a less aggressive stance. So I suggest splitting this portion of your windfall 50-50 between a total stock market index fund and a total bond market index fund such as the ones listed on our Money 70 list of recommended funds. Alternatively, you could just choose a balanced fund, which is a type of fund that usually keeps between 40% and 60% of its assets in stocks and the rest in bonds. You can screen for balanced funds with low annual expenses with the Morningstar Fund Selector.

3. Get your spending under control. If you continue to live hand to mouth, steps one and two will very likely have little lasting effect. If you really want to create some long-term security for yourself, you'll have to start living a financially responsible life. Whether you do that by creating and sticking to an actual budget, by just having a certain percentage of your salary (say, 10% or so) automatically go into a savings or investment account or by trying other strategies doesn't really matter. What's crucial is that one way or another you learn to live on less than you earn so you can save on a regular basis.

You can always refine your investing strategy later on. For now, though, concentrate on taking these three steps and creating some stability in your financial life. Because unless you do that, chances are your windfall won't sustain you for very long, and you'll once again find yourself anxiously awaiting your next payday.