How Should I Spend Insurance Windfall?

[PEERless]

Fastlaners:

I'm about to get a check from a family member's life insurance policy, and I wonder how best to use it. I could ask Suze Orman, but I want to hear some fastlane thoughts. Here's the situation:

1. I have a positive net worth, with most of my money tied up in a non-cash-flowing investment condo. Mortgage @5.75%.
2. I have five digits of student loan debt @4%.
3. I have five digits of credit card debt @8%.
4. I have a stellar credit score, and and above-average-paying job.
5. I have my cute li'l company and my cute li'l book producing negligible income.
6. In a week, I'll receive a check for almost five figures.

So, what would you do with it? Pay down debt? Buy stock? Invest in my business*? Store up cash? All of the above? None of the above?

Thanks, in advance for your creative ideas!

*BTW, if you tell me to invest in my business, tell me what specifically you would do. I've already dumped a lot of money into that hole (see Item #3 above.)

 

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[JScott]

In my opinion, it's a no-brainer...

You have 5-figures in credit card debt at 8% and you're getting nearly 5-figures in insurance money...PAY OFF THE CREDIT CARDS...

Again, absolutely a no-brainer...

 

[MrPink]

Fastlaners:
*BTW, if you tell me to invest in my business, tell me what specifically you would do. I've already dumped a lot of money into that hole (see Item #3 above.)

PEERLess, buddy.

I know you have read the 'how to make a plan post' by RussH.

 

[PEERless]

In my opinion, it's a no-brainer...PAY OFF THE CREDIT CARDS...

Believe me, I'm familiar with the traditional wisdom of a virtual 8% return. But I also know that tough economic times have different rules. Should I save some cash? (I have no savings). Or are there business applications that would return more than 8%?

I know you have read the 'how to make a plan post'

Yes, I have... Elaborate?

 

[MrPink]

I figure that you would have a plan for your business that is detailed enough in nature so that you know what you are going to do next.

What has worked, what has failed, how do you know, what are your goals... you know..

I assume that you are approaching this from the standpoint of being open to suggestions, but am unsure if anyone here knows your business well enough to give you specific suggestions on how to improve it.

The feedback on here is wonderful, for example, suggestions on your book's website, but to be analyze your whole business in enough detail to then be able to give specific suggestions seems a bit much.
--
I would also kill the CC debt, you maybe able to get a better return elsewhere, but there is always risk which is often difficult to calculate/predict.

 

[PEERless]

I figure that you would have a plan for your business that is detailed enough in nature so that you know what you are going to do next...I would also kill the CC debt...

I see what you mean. Yeah, I have a plan, but my life has changed in a lot of ways recently. Now that I have a baby, I'm a bit more conservative and careful. Thanks for the thoughts.

 

[MJ DeMarco]

Based on all the data you've provided, I'd take 80% of the windfall and pay down the credit cards. The other 20% I'd use to start your "nest egg". While the best return would be to use all of it toward your CC debt, I think you should get into the mindset of building a nest egg / savings. You have to start somewhere. Why not now? The "destination" of the Fastlane is residual income and that starts with building a portfolio of "something". For me, that "something" is cash as it generates hands-off income, even in this low interest rate environment.

 

[kidgas]

First of all, when might you need the money and could you get it back quickly in an emergency? I don't want to tell you what to do, but I will offer a possibility.

As you know, I like to invest in the stock market and specifically use stock collars for protection and income. I would look at a stock like EBAY. Today, you could buy it for 16.68 and buy the Jan 2011 17.50 put for 4.20. That means your total cost is 16.68 + 4.20 = 20.88. With $10,000 in a margin account, you could probably pick up 800-900 shares. As it stands, your maximal risk is 20.88 - 17.50 = 3.38/share on a 20.88/share investment or 3.38/20.88 = 16.2%. Then I would turn around and sell the June 18 call for 0.50/share and not look at it until the third week of June. Your new basis is 20.38 with a maximal at risk of 2.88/20.38= 14.2%. Then, you have 19 months to sell calls and only have to make 2.88 during that time to guarantee break even. You wouldn't have to do much following except once a month. See this article:

TRADING FLOOR SECRETS: The Lazy Stock Collar - Optionetics Commentary

Anyway, just my 0.02 even though probably not even worth that.

 

[Edge]

Can you give us a ratio of what the insurance policy is vs your CC debt?

 

[PEERless]

Based on all the data you've provided, I'd take 80% of the windfall and pay down the credit cards. The other 20% I'd use to start your "nest egg"...

This is kind of what I was thinking. I have a retirement account, but I don't have emergency reserves of cash -- hence CCD spending. 80/20 sounds good.

...Today, you could buy it for 16.68 and buy the Jan 2011 17.50 put for 4.20...

Ack! I just felt really dumb!

Can you give us a ratio of what the insurance policy is vs your CC debt?

The insurance payout is about 2/3rds of my CCD debt. If I used MJ's 80/20 idea, it would pay off half my CCD debt and put four figures into savings. Then maybe I could roll the CCD debt into a 0% balance transfer (my credit score is in the 790s) and cut up the cards.

And, Kidgas, don't worry. I'll put some percentage of my savings into my brokerage account. But I'm more of a buy'n'holder... which should be rewarding in the coming decade.

Does it sound like a Plan, guys?

 

[MrPink]

80/20 idea is great.

The last thing you want is for an emergency to come up and have to use the credit cards.

 

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[Russ H]

I see what you mean. Yeah, I have a plan, but my life has changed in a lot of ways recently. Now that I have a baby, I'm a bit more conservative and careful.

Your PLAN is a living thing, PEERless.

When you change, it needs to change w/you.

You need to revisit your PLAN and incorporate what's happening. And, you need to figure out if your goals/priorities have changed (always possible).

In the past 8 years, we've done this more than a dozen times. Times change. People change.

PLANs change.

-Russ H.

 

[PEERless]

PLANs change.

True that. I need to work on a new plan. BTW, is your use of capitalization in "PLAN" an acronym? I never figured that out.

 

[JScott]

I would look at a stock like EBAY.

Take it for what it's worth, but eBay is -- by far -- the worst-managed company I've ever personally seen...

I'll let others determine that correlation to the stock price...

 

[Russ H]

Skyler-

Nope. No acronym.

I got it from reading Diane Kennedy's posts on the richdad forums long, long ago (year 2000, if I remember correctly).

She capitalized PLAN to differentiate it from just doing a to-do list, or "making plans". Calling it a PLAN made it something that stood alone-- something bigger than goals or plans.

Least that's how I saw it-- all these years and I never once asked her why she put it in caps back then! :shruggie:

-Russ H.

 

[hakrjak]

In my opinion, it's a no-brainer...

You have 5-figures in credit card debt at 8% and you're getting nearly 5-figures in insurance money...PAY OFF THE CREDIT CARDS...

Again, absolutely a no-brainer...

JScott and I are of the same mind here. There is no reason for any fastlaner to have any credit card debt, unless it's temporary & directly tied to a project that will produce a profit. There is simply no excuse for this -- Pay it off immediately.

- Hakrjak

 

[lightning]

I agree with MJ. As I was reading the part of your post regarding having CC debt but no savings, I IMMEDIATLY thought (80-90% towards the debt, 10-20% into savings for a safety net), so i was happy to see that Mike quoted those exact numbers (shows Ive learned something after all these years ).

This situation truly strikes home with me, because 4 years ago, I was in a similar situation (only without the 5-figure windfall check on the horizon! lol). Upon graduating college, I had almost 8k worth of CC debt, and maybe $500 bucks in the bank at any one time (at the time, I was making about 36k a year). ALL of my money was poured into living a lifestyle I couldnt afford, eager to show people just how "successful" i had become after HS. I bought expensive clothes, nice watches, took my GF out to dinner 3 times a week, poured money into my car for things like expensive rims, stereo, etc. It was the beginning of a trend that could have crippled me well into my 30's, had I not started talking to MJ and experienced the epiphany I did.

What Hak and Jscott said is the truth. In the fastlane lifestyle, the only reason to have CC debt is to own an income producing asset thats paying you a greater return. For me, getting that debt down back then became an addiction. It was ALL i could focus on. Once I finally stood up and said, "I am going to be debt free within one year", my entire lifestyle changed. ALL the extra money I had went towards eliminating those bills, and in fact, I began to brainstorm CONSTANTLY about anything EXTRA I could do to throw more money at it! (extra bonus check at work? Right over to my chase account. Something I found in my apartment that I could sell? Right over to my BOA CC card). It was ALL I focused on.

Once it is paid off, there is a feeling of freedom having those lines of credit open with nothing looming over your head. It is just an awesome success.

Being a little conservative now that you have a baby is a good idea, so your head def seems to be in the right place. My advice is to dump about 80% of it towards those cards, and put the rest into an accessible, interest bearing account in case you need it.

Good luck man.

 

[PEERless]

There is no reason for any fastlaner to have any credit card debt, unless it's temporary & directly tied to a project that will produce a profit.

That's how I thought of it, but I overspent on book advertising before I understood that I wasn't converting. Bought a LOT of pageviews, though... LOL!

I IMMEDIATLY thought (80-90% towards the debt, 10-20% into savings for a safety net)

Your story sounds similar to what I did -- the first time I ended up in debt. I came out of college having spent about $10G on tacos, TVs, and Jaegermeister. It got to the point where it was almost too much to bear, so I paid it off. Got a second job. Stopped going out. Paid it down to zero. I vowed it would never happen again...

Fastforward to a little over a year ago. "I'm gonna start a business. Of course the money I invest in it will return more than my credit card interest. I have a brilliant idea."

And here we are.

 

[unicon]

Peer

There is no right or wrong way, you must choose, but the addition of a little one is already an issue for you per your own admission which spells conservative.

The rule is: Where there is debt there is more management. Management takes time. Typically an older person heading for retirement will payoff all debt just to simplify existence and focus on other things. Debt management is also a skill which you have to evaluate.

Example: One time I had debt service on a dying company of approximately $700,000 not including another operating debt of $300,000 growing while buying time. This was after putting down $250,000 on the purchase approximately 6 months earlier. This was from willfull undisclosed debt at the point of sale.

At the time maintaining control of the company would be linked to my salvation and I had to turn debt into an asset (another story). By defining and identifying the problem (similiar to RK differentiating between a house and a asset) I was able to find a solution. The solution took many forms but the ability to manage the debt and string out the debt while keeping the company operating was a working capital and debt service focus. This took a level head, proper perspective, confidence, and TIME.

If you have the above ingrediants and can multiply your cash and cash flow you may leverage your debt. If you do not allocate the time that choice is not in your arsenal.

 

[terrycan]

Dear Peerless

The 80-20 advice on the credit card debt sounds good.

You should be working with a financial planner.

He can work with you on your goals.

Debt elimination, retirement, college fund for your child.

If you can make small steps towards your goals every month you should double your net worth every 12 years.

Only invest in stocks if you can afford to lose that money. Stocks are like a boat. Hole in the water you enjoy poring money into.


For investing check out the markowitz formula. Money in three places, large cap, small cap, and foreign markets. Rebalance every six months. This way you buy low sell high and will consistantly beat the DOW.

:fastlane:

 

[hatterasguy]

Pay off the CC debt, thats bad debt in every sense of the term, get rid of it.

Still times are hard and you lack a cash reserve, so I'd put 1/4 of that money in the bank to start a reserve. You really want at least 6 months of your expenses as a reserve. Even more if you decide to work for yourself in a market like this.

 

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[MrPink]

You should be working with a financial planner.

I am against this idea. Work toward educating yourself about your finances.

For investing check out the markowitz formula. Money in three places, large cap, small cap, and foreign markets. Rebalance every six months. This way you buy low sell high and will consistantly beat the DOW.

Comparing this allocation to the DOW is incorrect since they differ greatly in market cap. Greater risk has yielded, greater reward over the long term therefore small cap (riskier) will out perform the DOW, if history holds.

 

[PEERless]

I got it! And here's what I did:

• 10% Savings. $0.10 of every dollar I receive goes into an ING Direct account that pays decent interest. Then quarterly, 10% of that balance goes into my dollar-cost-averaged investment plan.
• 10% Discretionary. I read that it is important to enjoy some part of the windfall, so rewarded myself.
• 80% Debt Repayment. Finally, I dumped the remainder into my credit cards. This lump pay-down also decreases my monthly minimums, so that I'll make more headway faster.

Thanks for all your help!

 

[MJ DeMarco]

Skyler,

Once you are "debt free" I suggest moving to a "cash only" basis and build a reserve fund for those emergencies. You will truly love the feeling of having no debts -- like having a weight lifted off your back.

 

[kidgas]

First of all, when might you need the money and could you get it back quickly in an emergency? I don't want to tell you what to do, but I will offer a possibility.

As you know, I like to invest in the stock market and specifically use stock collars for protection and income. I would look at a stock like EBAY. Today, you could buy it for 16.68 and buy the Jan 2011 17.50 put for 4.20. That means your total cost is 16.68 + 4.20 = 20.88. With $10,000 in a margin account, you could probably pick up 800-900 shares. As it stands, your maximal risk is 20.88 - 17.50 = 3.38/share on a 20.88/share investment or 3.38/20.88 = 16.2%. Then I would turn around and sell the June 18 call for 0.50/share and not look at it until the third week of June. Your new basis is 20.38 with a maximal at risk of 2.88/20.38= 14.2%. Then, you have 19 months to sell calls and only have to make 2.88 during that time to guarantee break even. You wouldn't have to do much following except once a month. See this article:

TRADING FLOOR SECRETS: The Lazy Stock Collar - Optionetics Commentary

Anyway, just my 0.02 even though probably not even worth that.

EBay closed at 17.28 yesterday. I would put in a GTC order on the July 18 calls to sell at 0.45 and see if it sells next week.

Now obviously you paid off debt which is a guaranteed return on investment and a wise choice. I am just pointing out an alternative for anyone who might be interested.

 

[PEERless]

Skyler,

Once you are "debt free" I suggest moving to a "cash only" basis and build a reserve fund for those emergencies. You will truly love the feeling of having no debts -- like having a weight lifted off your back.

That's the goal. I'm older and wiser now. I have an excess of cash coming in, so I can focus on plugging the holes in my pool -- then it's time to fill it! Thanks, MJ.

 

[GlobalWealth]

Sorry i just got on the forum, but I would have suggested a different approach. As you stated, you have a high credit rating, so I would have found a credit card (or 2) that offered 0% for balance transfers and transferred your balance to save on the interest payments. Since the other debt is at a low interest rate, I would continue making those payments (esp on the home as interest is tax deductible anyway), and invest the windfall in some income producing investment. Personally, I am an active investor and options trader, so I would put it all into an investment account as margin and trade options, but unless you know how to do this successfully, this is a great way to lose it all. if you are not an educated investor (not meant as a bad thing, but you need to know your limits), I would spread the money across a few index funds like ones offered through Vanguard. You would elect to have all dividends reinvested to further maximize your gain. Continute making payments from your salary on your debt including the CC debt that is now at 0%. Do not cancel any credit card accounts, as this will decrease your score. The longer you have credit, the better your score and the larger your available credit. But just because you have them, doesn't mean you use them. cut the cards, but don't cancel the accounts. if you haven't paid off your debt by the end of your 0% intro period (usually 6-12 months) find another CC offering 0% and roll the debt to that one. keep that going until you pay the debt off. You also need to automate your savings by electing to have some percentage of your income automatically invested into your index funds. you would need to determine your level of comfort here, but 5% should be your absolute minimum, and them much greater once you pay the debt.

in this scenario, you get interest free loans, start your nest egg, and pay down your debt.

 

[terrycan]

If you have credit card debt any investment will have to perform at the card interest rate for you to get a zero gain.

My advice:

1. pay the credit card debt

2. educate yourself about money

3. work with a financial planner