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Money Question: What Would you do with a Windfall? Part 3

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Money QuestionsYesterday, I published part 2 of What Would You Do With a Windfall. If you missed that, it might be worth clicking on that link back there to catch up. What did I ask the bloggers? Simply this:

Where is the single best place to invest a $50K after-tax windfall now? Assume the following: you don't need the money for at least 10 years, you've already max out 401k and Roth IRAs. Pretend that the windfall came under a couple conditions (like Brewster's Millions)... 1) You can only invest it in one area. 2) If your investment doesn't make 6% a year you lose it all.

Sun from The Sun's Financial Diary responded with the following two possibilities:

Right now, I don't have any big plan (like owning my own business) in my mind, but if I could get a windfall of $50,000 or even $100,000, then I will use the money as part of the down payment to get a bigger house. Now that we have two children, our three-bedroom townhouse is kind of small. Though they can still share a room for a while (we have two daughters), we will have to buy a bigger one at some point and the extra money can definitely help. We'd love to get a single house with basement so the children can have space to play. Also, both my wife and I like to play table tennis a lot. We could setup a table in the basement for ourselves and that's like dreams come true.

If there's any money left after we buy the house, I plan to invest it for the future. Actually, I already have a target and that's Vanguard Total Stock Market Fund (VTI). I don't mind to invest in a lump sum as it's almost impossible that the market will be down in the next 20 or 30 years. Thus, if the money is available, making a lump sum investment is the best choice for the long term. Also, since the fund covers the entire US stock market, I will get the maximum diversification with a single fund, which is also very cheap.

Sun, I think you might lose your home, due to the Brewster's Million's clause. However, if you can sell it off at the end of 10 years for the 6% a year gain, it could work out - leverage is an amazing thing. As for VTI, I own it and can't recommend it highly enough. The only problem I have right now, is that I think the stock market (on a whole at least) is over-valued.

Golbguru of Money, Matter, and More Musings has a couple of ideas of his own.

Here are some of a few not-so-concrete thoughts I had since I started working on the question:

Option 1: I would love to use that money to start a *good* restaurant on campus (or very near to campus). A few semesters ago, we (me and some of my classmates) did some ground work (for a class) on what would be required to open a restaurant in our town ~ I would like to see some realization of those ideas. With the kind of numbers we played at the time, we estimated that we would break-even (with respect to the initial capital) in about 3 years ~ and the earning rate will increase more with increasing popularity (and increasing enrollment of new students). Plus, it's a university town - students are busy - they tend to eat out a lot and that works in our favor.

Option 2: Invest it in energy in a sort of "hedging" manner - gasoline, sun, wind, hydrogen, and nuclear. Like Henry (from Binary Dollar mentions in his answer - the demand for energy is never going to head down - gasoline may be replaced by hydrogen in the time to come - but you will need something to keep those millions of cars running. I don't know what kind of a returns this will give me...but since it's an unexpected windfall, I would be willing to take risks with it.

Going from 50K to 100K would definitely make me think more - although I don't think it will affect my choice much (if it were $1 million, that would certainly make me change my choices). The time factor will also matter a lot - technologies become old and new ones attract more attention - accordingly, I wouldn't want to stay rigid on the energy investment options. I would stay in the broad "energy" field, but my options would depend on what's hot at the time. With the restaurant, it doesn't matter if the time frame is 10 years or 50 years - if it's a good restaurant, it will be etched on people stomachs for ever. :)

The restaurant idea is pretty interesting. There are a lot of restaurants out there, so I've always discounted the idea. I figured the competition is too high and the audience is limited (by geography). The other side of the coin is that there are so many restaurants, they must be doing something right - right? As for the energy, I like the idea overall, but I'm glad you are willing to take some risks with it. That was the spirit of the exercise. I should have probably asked for more than 6%, but I didn't want to limit too much and I wanted to eliminate the high interest savings accounts.

Let me know in the comments, what would you invest in? Can you guess what I would invest in? I'll give a hint, it's not Prosper (at least under these restrictions). Expect my answer later today... or Saturday.

Last updated on June 16, 2007.

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6 Responses to “Money Question: What Would you do with a Windfall? Part 3”

  1. MossySF says:

    Serious answer this time. From reading through the answers, the stipulation has almost everybody fooled. What it is has effectively done is remove risk for high risk investments and incentive for “safer” options. Let’s go through the math.

    Number of periods the SP500 has returned less than 6% during 1928-2006: 30 (38%)

    Ordinarily, the odds table looks like so:
    * 38% = $50K less than 6%
    * 62% = $50K more than 6%

    The stipulation changes the outcome like so:
    * 38% = $0
    * 62% = $50K more than 6%

    In effect, it has turned an investment choice into a gambling choice. As a consequence, we should be looking for gambling options to compare it to. I’m not familiar with all the Vegas options so I don’t know exactly which game to play. But I’d pick the one closest to 50:50 odds and then throw everything down on a single hand/roll/throw. That would produce an outcome table of:
    * 52% = $0
    * 48% = $50K 100%

    While the odds of ending up with nothing has increased from 38% to 52%, the rewards of success are up 10X. This is a far better risk/reward ratio.

    For a longer timeframe (say 5 years to produce 6% annualized returns), Golbguru is closest to the answer. Let’s look at the historic numbers.

    Number of 5-yr periods the SP500 has returned less than 6% during 1932-2006: 21 (28%).

    Odds a bit better in your favor but nearly 30% is is quite the risk. My strategy here would not be Vegas but to start a small business (restaurant, boutique clothing, flowers, etc). Small businesses have big failure rates but they also have far higher returns than passive investments — otherwise, why would people take the risk of losing the entire investment versus only losing X% in stocks/bonds? Again, the stipulation removes much of the risk for what normally is a risky proposition. You already have a high chance of losing it all — pick an option with high returns with matching risk to the stipulation. If you succeed, you have a successful business returning 25% ROI on top of your replacement salary.

  2. Sun says:

    If I were indeed having that amount of money to buy a house right now, I don’t think I will sell it 10 years later even if it appreciates more than 6% annually. House is an investment, but more it’s a residence. And if we are comfortable with a bigger house, selling it and moving to a smaller one won’t be an easy decision.

    As for investing in VTI, I think over-valued is only valid for short term investment. If I am going to hold it for 10, 20 years, why would I be concerned by how much is the stock selling now? If I only want to hold it for, say, 1 year, then I may consider if it’s the right time now.

  3. Wylie says:

    If I had it I would invest it in the 20 mutual funds I picked on my site and labeled the “WylieMoney Portfolio”:

    http://wyliemoney.blogspot.com/2007/05/real-scoop-managed-funds-index-funds-or.html

    I feel confident that over 10 years, this portfolio will earn more than 6% a year on average.

    I actually picked funds with a $2500 or lower initial minimum investment so $50,000 is exactly how much I would need to buy it all at once.

    Also, I like your site and am adding a link to it to mine. Please link back!

  4. MossySF says:

    Doing the win-or-nothing math one time for a 10 year cycle — the SP500 returned less than 6% over rolling 10 year periods a total of 12 times since 1937-2006. What this means is putting your money in stocks over 10 years, you have a 17% chance of losing it all according to the stipulation.

    This odds fits perfectly with options trading. If you’ve read any of the books from Nassim Nicholas Taleb, you may be familiar with the terms “fat tails” and “black swans”. Basically, black swans are events that according to natural distribution should be very rare but yet happens often in the stock market. A brave options trader who sells puts can continually make money in the typical market — a lot of money. However, when black swans happen (Black Friday, Russians defaulting on bonds, 9/11), such events completely wipe your funds out. Here’s an article describing such a simple strategy:

    http://www.econbrowser.com/archives/2005/11/hedge_fund_risk.html

    7 year run of 41% annualized returns and then black swan in ’99 wipes you out. Ordinarily, this would be a crazy investment idea — no one would willingly invest in a strategy that has a 14% chance of a -100% return in any given year. Except with the windfall stipulation where underperformance wipes you out at a 17% rate over 10 years, this strategy is the perfect fit. So you end up with an outcome table of:
    * 14%: 0
    * 86%: 50K x 3100% = 1.5M

    By comparison, investing in simple stocks has an outcome of:
    * 17%: 0
    * 83%: 50K x 260% = 130K

    In this case, you not only take more risk with stocks but accept much less returns for it. Now, before I undertook such a risky strategy, I would make sure all my assets were in vehicles protected from bankruptcy (like 401Ks, IRAs, cash value insurance). This is to cover the case where the market moves so fast that I am unable to cover my positions and I am on the hook for MORE than what I invested.

  5. […] of posts on other excellent personal finance blogs, about what one should do with a windfall. (See lazy man and money and blueprint for financial prosperity). In the days before I started plonkee money, but after I […]

  6. Jacqueline J. Young says:

    I actually want to think about investment and stuff in the coming years because I wanted to quit my job and live a life, and earn online ( I have some online clients I deal with) and I browse upon ioption broker review sites ioptionsreview.com and was able to read more about binary options. I even attended their webinars and read their e-book to have a better knowledge of it. In your own personal opinion do you think investing in binary options once in a while is good or not?

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