Do you ever watch those TV game shows where the winner takes away a cash prize and the host asks them what theyre going to spend it on? Im waiting for someone to say Im going to beef up this years ISA with it, grabbing myself a few tasty looking blue-chip dividends. But no, theyre always going to learn to play the tuba, or repaint the dog, or something.
I can understand how tempting it is. After all, a 10,000 windfall would buy you a very nice round-the-world holiday, or a decent car to replace your clapped-out old banger. Or 714 Wicked Variety Buckets from KFC (and please dont ask me what they are the name alone makes them sound too horrible to contemplate).
How much are you paying?
But wouldnt it be great to hear Ill pay off my credit card bill with it? Carrying credit card debt is one of the biggest financial mistakes you can make, and its where any spare cash should go before you think of anything else. Even a number of the established credit card companies are charging annual interest rates at around the 30% mark, and that adds an awful lot of cash onto the price of whatever it is youre buying.
So before you think of spending a penny of any windfall on anything else, you owe it to yourself to get those credit card debts down and you should really get rid of all debts other than your mortgage before you think about investing.
Next up should be some cash to cover emergencies, but how much? Conventional wisdom is that you should keep the equivalent of around three months expenditure in a quick access savings account, and thats probably about right.
ISA time!
Once youve got your debts sorted and youve accumulated a sufficient rainy-day fund, youre getting into serious investing territory. Its then time to turn to an ISA and I mean a shares ISA and not a cash ISA. An ISA currently allows you to invest up to 15,240 a year and have most of the returns protected from tax so if you buy shares today and theyre much higher in value in 10 or 20 years time, or whenever you retire, you wont pay a penny in tax on the gain.
Why shares and not cash? Well, for the past century and more, money invested in shares has beaten cash hands down. Today, you might get 2-3% interest per year from your bank if youre lucky, but there are top FTSE 100 shares out there offering 5 to 6% and more in dividend income alone were talking of companies like GlaxoSmithKline which paid 5.8% in 2015, Legal & General on a prospective yield of 5.4%, and SSE on a forecast 5.8%, and these arent high-risk outfits that are going to go bust tomorrow.
Shares will trash cash
The difference is a big one. If you could get 3% from cash savings, youd turn your 10,000 into 18,000 in 20 years. But a dividend income of 5% per year would turn the same money into 26,500, and thats before any share price gains. If you achieve a very modest 3% gain per year in share prices in addition, youll be sitting on 46,600 after two decades and even an extra 1% above that would take you up to 56,000.
And 56,000 of future cash is a lot to sacrifice on a short-term treat (unless youre already a successful investor and your future comfort is already secured, in which case go blow the cash and have fun!)
But you know what? You don’t need to wait for an unexpected windfall to get investing. No, you could even achieve millionaire status by the time you retire by making regular monthly investments over the decades of your working life.
To find out more, get yourself a copy of the Motley Fool’s special 7 Simple Steps For Seeking Serious Wealth report, which shows you how investing in shares and reinvesting dividends has wiped the floor with every other form of investment over the past century and more.
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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended GlaxoSmithKline. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
