Seven things to do with a windfall

Be it an inheritance, maturing bond, win on the lottery or just a generous gift, here are some great options for saving and investing a lump sum of £5,000.

A friend of mine was recently left £5,000 by an elderly relative. And while many of us would probably be racing to the nearest travel agency to book an exotic holiday, in the current economic climate she is inclined to do something sensible.

But what could she (or any of us) do with £5,000?

1.    Boring, boring

Yes, this is dull, but if you have expensive debts (personal loans and credit cards being the main culprits) the way to get the most out of a lump sum is to pay them down.

It’s not rocket science – anyone can see that a £5,000 debt on a credit card charging 12% APR is growing faster than £5,000 saved into a 3% savings account.

Pay off expensive debts first and you’ll save more in interest than you could make.

2.    Emergency fund

Once those debts are out of the way, you need a plan to not get into debt again – and the best way to do this is by having an emergency fund.

This is simply a pot of between three and six months' living expenses saved into an easy access savings account, and provides a bit of financial security should an unexpected bill arrive.

3.    Cash ISA

Once the first two topics have been tackled, we can consider saving in an easy access account. Cash ISAs allow over-16s to save £5,340 per year, and the best bit is the interest earned is paid free of tax.

Over a year, £5,000 in a savings account paying 3% would earn a basic-rate taxpayer £120 in interest (a higher-rate taxpayer would earn just £90).

But save that money into a Cash ISA paying 3% and you’d earn £150.

Top instant access accounts at the moment include the Newcastle BS Bonus ISA, paying 3.05% AER (including a 12-month, 0.95% bonus) and the AA’s Internet Access ISA, also paying 3.05% AER (including a 12 month 1.35% bonus).

For longer-term accounts, Northern Rock is offering 3.3% AER on its Fixed Rate e-ISA (min deposit £500). Yorkshire Bank is also paying 3.3% AER on its Fixed Rate Bond ISA (minimum deposit £2,000).

4.    Pay down your mortgage

But of course, inflation is the real killer where saving money is concerned, especially when coupled with pretty uninspiring savings rates.

Which is why the next idea may be more appealing – paying the lump sum into your mortgage.

Firstly, you’ll be reducing your debt. So, a £100,000 debt will be reduced to £95,000. And of course, a smaller debt accrues less interest. Assuming you have a 25-year repayment mortgage at 4% APR, instead of paying £528 per month, you’d be paying £501 per month – saving £27 each time.

But even better, if you were to continue to make the same mortgage payments of £528 each month (effectively overpaying by £27 per month) you could save a whopping £5,229 in interest payments, as well as pay off your mortgage 2.1 years early!

Just ensure you check the details of your mortgage with your provider to ensure paying in a lump sum won’t subject you to any early repayment fees or penalties!

Try out this mortgage overpayment calculator and see how much you could save.

5.    Boost your pension

If your retirement fund isn’t as healthy as you’d hoped, your pension could prove a sensible home for your lump sum.

Every £80 stashed into your pension is boosted by £20 by the Government – and that’s whether you’re a taxpayer or not. Higher-rate taxpayers can claim an extra 20% via their tax return.

What’s more, if your employer matches your contributions (and you’re not currently paying in the maximum) you could be really canny. By using your lump sum to boost each month’s contribution, your employer may match the increase – meaning you gain a little more.

6.    Invest it

And of course, you could invest the cash yourself. History shows us that, over the long term, shares tend to do better than cash, and investing is definitely worth considering once you’ve got your emergency cash fund in place.

There are many ways to invest – shares and managed funds are great options but do require you to spend some time doing your research first.

A far simpler option is one of our favourite products – the index tracker. Trackers offer a great way to invest without having to put in very much effort - and with no initial fees and low annual charges you keep more of what you make, too. You can even hold them as part of your ISA.

Indeed, when you realise nine out of ten managed funds fail to beat the index, you can see that they’re a smart choice too. Just remember, index trackers should be seen as medium to long-term investments!

7.    Premium Bonds

But if you’re after a bit of fun, another option is to buy some NS&I Premium Bonds.

You can hold between £100 and £30,000 in bonds and your capital is safe (NS&I is, of course, Government backed). Instead of paying you interest each month, the interest rate funds a prize draw, meaning your bonds could win between £25 and £1m each month! Fantastic.

But all that glistens is not gold. For a start, the interest rate used for the prize draw is a measly 1.5% AER. The odds of winning per £1 unit are 24,000 to 1, and the odds of winning the £1m jackpot are 14 million to 1. You’re better off stashing your cash elsewhere for a more guaranteed return.

But, if the lottery effect is what you love, there are worse places to stash your money (just maybe not the whole £5,000!). After all, you could argue that someone’s got to win, haven’t they?

So there you have it, some ideas to make the most of a cash lump sum.

Good luck!

More: Get ready for the biggest pension shake-up in history |The 10 best Cash ISAs