Inherited a substantial sum of money? Here's how I'd spend it (including the ASX stocks I'd buy)

Inheriting a substantial sum of money can be life changing – but working out the best way to use it comes with its own pressures.

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Given the topic, I'll try to keep this article as light-hearted as possible. Let's assume that one day, out of the blue, you get a call from a lawyer telling you that your mysterious great aunt Holga recently passed away at the ripe old age of 106. You can only remember meeting Holga once – on a family trip to Dusseldorf when you were still a toddler – but you must have made a good impression, because she decided to leave you all her worldly possessions, including a significant sum of money.

Sure, you feel sad for poor old Holga, but she had a good run. And so, before long, your thoughts turn to how you should spend this sum of money. It could set you up for the future – and might even allow you to retire early!

But you've never had so much money before, and it's hard to work out where to start. Should you invest it all in stocks? Should you use it to pay off your debts? Should you blow it all at the casino?

In this article, I take a look at some of the most prudent ways you can use your surprise cash injection. After all, it's what Holga would have wanted.

Pay off your debts

The first thing I believe you should do – before you even think about investing your inheritance on the ASX – is pay off as much of your outstanding debts as possible. Debt is the finance universe's equivalent of a black hole. It sucks all your cash into oblivion and significantly diminishes your ability to grow your wealth.

Trust me – although it might sound a bit boring, the best thing you can do if you come into a significant amount of money is to use it to wipe out your debt. It will be a huge weight off your mind, and a first step towards financial freedom.

Set aside an emergency fund

The second-best thing you can do (after getting rid of your debts) is to set aside an emergency fund. This is an amount of money you squirrel away to use in case something unfortunate happens – like you suddenly lose your job, have to pay a medical bill or have some other large, unexpected expense crop up.

Advice differs on how much you need to put into your emergency fund, but enough to cover between 3 and 6 months of expenses is a good rule of thumb. Ensure your emergency fund is somewhere you can access quickly and easily, like a high-interest savings account. Don't invest it in shares or other at-risk assets, because if you need that money in a hurry and those investments have lost some of their value, you'll be forced to sell them for a loss.

Income or growth?

OK, now that we've got the boring things out of the way, it's time to use whatever cash you have left to build an investment portfolio. But what sort of portfolio do you want to build?

You may decide to use your portfolio to supplement your income. In that case, you should build a portfolio weighted towards blue-chip stocks with stable valuations and consistently high dividends.

Good places to start would be leading Aussie bank Commonwealth Bank of Australia (ASX: CBA), mining giant BHP Group Ltd (ASX: BHP), or a favourite of mine, investment house Washington H Soul Pattinson & Company (ASX: SOL). A portfolio made up of just these stocks would pay you a dividend yield of about 4%, meaning you can expect an annual dividend income of $4,000 for every $100,000 invested.

Alternatively, you can park some of your money in a dividend exchange-traded fund (ETF) like the Vanguard Australian Shares High Yield ETF (ASX: VHY). This fund invests in a diversified portfolio of 71 ASX large-cap high-dividend stocks, including CBA and BHP, as well as diversified conglomerate Wesfarmers Ltd (ASX: WES) and telco Telstra Group Ltd (ASX: TLS), among many others. Its dividend yield is a little over 5% and charges an annual management fee of 0.25%.   

If you'd rather target growth there are plenty of great options on the ASX. I believe tech market darling WiseTech Global Ltd (ASX: WTC) is a good stock to watch, as is cancer drug company Telix Pharmaceuticals Ltd (ASX: TLX) and digital audio company Audinate Group Ltd (ASX: AD8). And a left-field choice to add to your watch list is Las Vegas-based gambling machine company Light & Wonder Inc (ASX: LNW).

There are also ETFs available for growth-oriented investors. The Betashares Diversified High Growth ETF (ASX: DHHF) provides exposure to a portfolio of about 8,000 global stocks with high growth potential – and charges an annual management fee of just 0.19%.

Motley Fool contributor Rhys Brock has positions in Audinate Group, Commonwealth Bank Of Australia, and WiseTech Global. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Audinate Group, Light & Wonder, Telix Pharmaceuticals, Washington H. Soul Pattinson and Company Limited, Wesfarmers, and WiseTech Global. The Motley Fool Australia has positions in and has recommended Audinate Group, Washington H. Soul Pattinson and Company Limited, Wesfarmers, and WiseTech Global. The Motley Fool Australia has recommended Light & Wonder, Telix Pharmaceuticals, and Vanguard Australian Shares High Yield ETF. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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