In general, people don’t do well with amounts of money significantly larger than they are used to handling. ?The most obvious example of that is people who win lotteries. ?The money typically gets wasted — bad purchases, bad investments.

Thus I would encourage you to be very careful with any large distributions of money that you might receive. ?Examples include:

• Life insurance settlements
• Disability insurance settlements
• Structured settlements arising from winning a court case over a tort against you.
• Lotteries
• Pension lump sums
• Inheritances
• Big paydays, if you are one of the rare ones in a high-paying short career like entertainment or sports

There are three problems with lump sums — receiving them, investing them, and rate of their use for consumption. ?Let me take these topics in the order that they should occur.

Receiving a Lump Sum

Let’s start with the cases where you have?a stream of payments coming where a third party comes to you and says that you can get all of the money now. ?I am speaking of structured settlements and inheritances where trusts have been structured to dole out the money slowly. ?There is one simple bit of advice here: don’t do it. ?Take the payments over time. ?None of the third parties offering to give you cash now are giving you a good deal, so avoid them.

Then there are the cases where an insurance company is making the payments from a disability claim, a structured settlement, a lottery, a pension buyout, or an annuity that someone bought for you on your life. ?The insurance company will be more fair than any third party, because they aren’t usually looking to make an obscene gain, just a big one, because it reduces their risk, and cleans up their balance sheet, so they can do more business. ?One simple bit of advice here: still don’t do it. ?You can do better by taking payments, and building up money for larger purchases. ?Be patient.

People do best when they receive money little by little. ?When they get money materially faster than the speed at which they have previously earned money, they tend to waste it. ?It is almost always better not to take a lump sum if you have the option to do otherwise.

The last set of situations is when the party that owes the set of payments?offers you a lump sum. ?It could be a life insurance company, a defined-benefit pension plan, a lottery, or some option uncommonly granted by another payor. ?I would still tell you not to do it, but the issue of getting cheated is reduced here for a variety of reasons.

The defined benefit plan has rates set by law at which it can cash you out, so they can’t hurt you badly. ?That said, you will likely not earn enough off of your investments with safety to equal the stream you are giving up. ?The lottery is often similarly constrained, but do your homework, and see what you are giving up.

One place to take the lump sum is with life insurance companies off of a death benefit. ?The rates at which they offer to pay an annuity to you are frequently not competitive, so take the lump sum and invest it wisely.

Economically, the key question to ask on a lump sum versus a stream of payments is what you would have to earn to replicate the stream of payments. ?Most of the time, the stream is worth more than the lump sum, so don’t take the lump sum.

The second question is more important. ?Can you be disciplined and not waste the lump sum? ?Ask those close to you what your money habits are like, if you don’t know for sure. ?Ask them to be brutally honest.

Investing the Lump Sum

Again, one nice thing about taking payments, is that you don’t have to invest the lump sum. ?If you do take the lump sum:

• First, pay off high interest rate debts.
• Second, avoid buying big things and calling them investments. ?Don’t buy a big house when you don’t need a big one.
• Third, don’t invest in any of your relatives’ or friends’ business ventures. ?Tell them you try to keep personal affection and money separate. ?It avoids hurt feelings.
• Fourth, look at the time horizon of your real needs. ?Plan for retirement, college, etc. ?Invest accordingly — get a trustworthy adviser who will help you. ?Trustworthiness is the most important factor here, with competence a close second.
• Fifth, don’t so it yourself, unless you have developed the skill to do it previously. ?If you want to do it yourself, you will have to gauge whether the various markets are rich or cheap in order to decide where to invest. ?For some general, non-tailored advice, you can look at articles in my asset allocation category. ?As an aside, don’t invest in anything unusual unless you are an expert.

Receiving Spending?Money from Your Investment Fund

The first thing is to decide on a spending rule: many use a rule that says you can take 4% of the assets from the fund. ?My rule is a little more complex, but will keep you safer, and adapt to changing conditions: as a percentage of assets, take 1% more than the yield on the 10-year Treasury Note, or 7% if less. ?At present, that percentage would be 2.21% + 1% = 3.21%.

Whatever rule you use, be disciplined about your spending. ?Don’t bend your spending rule for any trivial reasons. ?Size your budget to reflect your income from your investment fund and all of your other income sources.

Conclusion

Remember that most people who get a lump sum end up wasting a lot of it. ?The only thing that can keep you from a similar fate would be discipline. ?If you don’t have discipline, don’t take a lump sum. ?Take the payments over time. ?That will give you the maximum benefit from what is a very valuable asset.