Best Practices and Pitfalls to Avoid When Investing an Inheritance

June 5, 2025

Receiving a significant inheritance can be both a blessing and a burden. On one hand, it offers new financial opportunities that could enhance your lifestyle and future security. On the other hand, managing a sudden influx of wealth can be overwhelming, especially if you’ve never had to make decisions of this magnitude before. Without a clear strategy, it’s easy to make hasty decisions that could cost you in the long run, both financially and emotionally.

Explore the best practices for investing an inheritance, along with common pitfalls to avoid, to help you make informed, thoughtful choices that align with your long-term financial goals.

1. Reassess Your Risk Tolerance

When inheriting a significant sum, the first step should be to reassess your risk tolerance. Your investment strategy may need to evolve, particularly if your financial situation has changed dramatically. If the inheritance significantly increases your wealth, you might feel the urge to take on more risk in the hopes of higher returns. However, it’s important to recognize that taking on too much risk can lead to losses that could undo the benefits of the inheritance.

Consider your new financial picture and your comfort level with risk. If you’re closer to retirement or have specific goals for your inheritance—such as funding education or securing a comfortable retirement—it might make sense to adopt a more conservative approach. Conversely, if you’re younger and have a long time horizon for growth, you may feel comfortable taking on more risk to maximize your returns. Regardless of your situation, be sure to reassess and adjust your investment strategy accordingly.

2. Rebalance Your Asset Allocation

An inheritance can significantly impact your asset allocation, especially if it involves a lump sum of money. Your existing portfolio may become unbalanced, with too much exposure to a single asset class—such as stocks, bonds, or real estate—due to the addition of new assets. To avoid concentration risk, you’ll need to rebalance your portfolio to ensure it remains aligned with your goals and risk tolerance.

Rebalancing involves reviewing your current holdings and adjusting them to maintain your desired mix of assets. This can include diversifying across stocks, bonds, alternative investments, and real estate, among other asset classes. A well-balanced portfolio helps minimize risk by spreading your investments across different sectors and markets. This way, if one asset class performs poorly, the others can help offset the losses.

3. Leverage Tax-Efficient Strategies

An inheritance can bring significant tax implications, and understanding these is essential to making the most of your windfall. The tax treatment of inherited assets depends on various factors, such as the type of assets, the value of the inheritance, and whether it is a traditional or Roth IRA. Different types of investments are taxed in different ways, and some may provide opportunities for tax deferral or reduction.

For example, if your inheritance includes stocks or mutual funds, you’ll want to consider strategies to minimize capital gains taxes, such as tax-loss harvesting or holding onto assets for the long term to benefit from long-term capital gains rates. Additionally, inherited IRAs can be tricky, and there are specific rules regarding required minimum distributions (RMDs) and tax treatment that you’ll need to navigate carefully.

Working with a financial advisor who understands the nuances of tax planning can help you identify the most tax-efficient strategies for your inherited assets. By doing so, you can potentially reduce your tax burden, allowing more of your inheritance to grow and contribute to your long-term wealth.

4. Avoid Hasty Decisions

One of the biggest mistakes people make when receiving an inheritance is rushing to invest or spend the money. It can be tempting to act quickly, especially if you feel pressure to make the inheritance “work” for you right away. However, hasty decisions often lead to poor financial outcomes, as they may not take your long-term goals, risk tolerance, or financial needs into account.

Instead of rushing into investments, take the time to evaluate your options carefully. Seek professional advice and consider the long-term implications of your decisions. Whether you’re looking to invest in the stock market, purchase real estate, or fund your retirement, it’s important to make decisions that align with your overall financial strategy, rather than acting out of immediate impulse or emotion.

5. Consider Alternative Investments

While traditional investments such as stocks, bonds, and mutual funds are often a safe bet for many, it’s also worth considering alternative investments. Depending on your goals, risk tolerance, and investment knowledge, alternative assets such as real estate, private equity, or even commodities can provide diversification and potentially higher returns.

However, alternative investments come with their own set of risks and complexities. Real estate, for instance, can be an excellent way to generate income or build wealth, but it requires active management and comes with its own set of risks, including property depreciation and market volatility. Similarly, private equity can provide access to high-growth opportunities, but it often requires a longer investment horizon and carries a higher level of risk compared to traditional investments.

Before diving into alternative investments, ensure that you fully understand the asset class and its potential risks and rewards. A well-rounded investment portfolio typically benefits from a mix of traditional and alternative assets, providing both growth and stability over time.

6. Plan for IRA Withdrawals

If your inheritance includes an IRA—whether traditional or Roth—strategic planning for withdrawals is crucial. Depending on the type of IRA, you may be required to take minimum distributions (RMDs) once you inherit the account, which could have tax implications. Failing to manage these withdrawals properly can result in unnecessary tax penalties or missed opportunities for tax deferral.

For example, if you inherit a traditional IRA, you’ll need to understand the rules regarding RMDs and how they will impact your tax situation. If the IRA is a Roth IRA, you may not have to take distributions during your lifetime, but you’ll still need to understand the impact on your overall tax strategy.

A trusted advisor can help you navigate the complexities of IRA withdrawals, ensuring that you take the required distributions while minimizing your tax liabilities and preserving the value of the account.

7. Work with a Trusted Advisor

Inheriting a large sum of money is a significant life event, and the decisions you make now can have lasting implications on your financial future. Working with a trusted advisor can help you make informed, strategic choices that align with your long-term goals. An advisor can provide guidance on tax planning, investment strategy, estate planning, and risk management, ensuring that your newfound wealth is managed effectively.

A qualified advisor can also help you stay focused on your long-term objectives, avoiding emotional decisions that might compromise your financial stability. Whether you’re looking to preserve wealth for future generations, grow your assets, or live comfortably in retirement, an advisor can offer the expertise and insight needed to make sound investment choices.

Investing an Inheritance Conclusion

Investing an inheritance is an opportunity to secure your financial future, but it requires careful planning and strategic decision-making. By reassessing your risk tolerance, rebalancing your portfolio, leveraging tax-efficient strategies, and avoiding hasty decisions, you can make the most of your inheritance. Working with a trusted advisor can help ensure that your financial choices are well-informed and aligned with your long-term goals, allowing you to preserve and grow your wealth for years to come.

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Investment, trust and estate, and wealth planning products and services are Not FDIC Insured, Not guaranteed by the Bank, May Lose Value

This content is for informational purposes only and does not constitute legal or tax advice. Please consult your legal or tax advisor for specific guidance tailored to your situation. First Western Trust Bank cannot provide tax advice. Please consult your tax advisor for guidance on how the information contained within may apply to your specific situation.