Everyone knows what they would do with a $2-million windfall - until they are confronted with reality.

When it is real money, paralysis can set in on the dreams of a luxury house, an extravagant holiday, a designer wardrobe and other indulgences. Recipients of a windfall can become consumed by conservatism and fear of making the wrong decision, an attitude that can be almost as dangerous as embarking on an unrestrained spending spree.

Melbourne financial adviser Sylvia Dickson of Dickson Bonacci says some people start by investing the lot and leaving no room for fun.

And a couple of years later, when they decide that they want some money out of their investment portfolio, the strategy is turned upside down. The consequences can be expensive if the money has been locked away in a structure that is meant to be for the long term.

There are a few simple things to remember, Dickson says. It is important to get the right investment structure then allocate the assets; investors should not be obsessed by tax-driven investments; and they owe it to themselves to get the best advice available, specifically for their own circumstances.

Investment alternatives are becoming more complex and technical, and sometimes a little bit of knowledge can be dangerous. On the other hand, some investors have a handle on the best set of investments for them, and a plan might simply need a bit of tweaking to extract the best result possible. Advisers certainly prefer to deal with investors who want to participate in the investment process and who will remain actively involved. Striking a balance is the key.

To illustrate how investment plans differ and to reinforce the need to have a flexible program, BRW spoke to three investors at different stages of their investment cycle. Their task was to say what they would do with a $2-million windfall. Their own investment plan was then scrutinised by Dickson for refinement, or total rearrangement, depending on their investment profile.

1. First we spoke to a single female who has just finished university and joined the workforce. She has no substantial assets but has a debt under the Higher Education Contribution Scheme and a car loan, and she is living in a shared house.
2. Our second investor is a professional man in his early 40s, married with no children. He has a secure, well-paid job, owns his own home, has an investment portfolio and is a member of a corporate superannuation scheme.
3. The third investor is a man in his last 10 years in the full-time workforce, having clocked up a good length of service and superannuation that stands about four times his annual salary. This investor has one child at university and a wife who is self-employed. They have a family house, a small amount of debt and not a huge range of other investments.

Model one

The 20-something decided she would find a financial adviser, with the intention of putting $1 million into long-term managed funds that will grow until she retires. She would pay off her HECS debt and her car loan, buy a house or flat, go on an overseas holiday in style then still turn up to work on Mondays.

She is on the right track. Because she is so young and prepared to put half into long-term investments and return to work, she can afford to spend the other $1 million. If she sets herself up initially, it is less likely that she will need to draw on the investment funds in future.

Dickson says that, taking the simplest approach to outline her future position, the $1 million invested in superannuation at 9% for 38 years (which is her preservation age) would grow to $26.4 million, or $8.6 million in today's dollars, assuming inflation of 3% a year. At this rate, her investments would provide an income equivalent to $700,000 a year in today's dollar terms, indexed for "life".

However, Dickson says it is unlikely that a financial planner would recommend putting all the $1 million into superannuation because she would not have access to the money, there is a danger of legislative changes that might have an adverse effect on her funds, and she would exceed her superannuation reasonable benefit limit (RBL). It is essential to have the flexibility to review and restructure throughout the life of the investment plan.

Model two

The 40-year-old professional says he would invest. His aim is to get a 5% yield with capital growth. He says he would put $1 million into Australian shares - blue chips with fully franked dividends, mostly industrials with a smattering of quality mining companies. His aim is to buy into the market over time when yields are good.

He would allocate $100,000 to an income account likely to yield about 5%, and would put another $100,000 into bank bills to give some diversity.

To spread the portfolio, this investor would look at putting $100,000 into international shares through a managed fund and would also use a managed fund to invest another $100,000 in technology shares or shares in emerging companies.

Being an investor who is comfortable with real estate, he would spend $500,000 on a rental property for income and capital growth. When choosing the investment property, he would have one eye fixed on its land value.

He says he would use $100,000 to top up his superannuation fund. Finally, he would use his improved financial position to borrow, say, $300,000 to invest in imputation shares and a house with the aim of generating tax advantages that go with a geared investment.

He believes that the strategy would provide capital growth as well as income of $100,000 a year, which, added to his existing salary, would provide a very good standard of living. His first frivolous act would be to take a couple of friends to Melbourne's famous Flower Drum and blow $1000 on dinner.

Why invest for income? Unless the investor is planning to spend an extra $100,000, it is not the most effective strategy. Dickson says capital gains are more tax-effective than income, and capital-growth assets are likely to produce a greater total return than high-yield investments.

Dickson says that investors often separate yield from capital growth, whereas they should focus on total return. If your total return is better, does it matter whether you are spending income or income and capital?

She says the investor's plan should be reorganised to generate the minimum extra income needed and to set aside some of the windfall for capital expenditure, otherwise the asset allocation will be unnecessarily conservative.

Before he decides on the individual asset classes, this investor should do a thorough review of his objectives and timeframe, and he should select the investment structure that is most appropriate.

Dickson says not enough is being done to maximise superannuation tax concessions for the investor and his wife for money that is not needed before retirement. For instance, fewer tax-effective investments should be made in the superannuation fund if the tax rate is lower than their marginal tax rate. The low yield/tax-effective investments should be made in their own names, particularly if capital gains are to be realised after retirement and reduction in the marginal tax rate.

Dickson says that despite the investor's attraction to residential property, she thinks it is a mistake to put $500,000 into one property. She says it becomes a single asset in a single location, which adds up to a lack of diversification. "If he wants property, he should spread the money over different property investments, which could be through property trusts, syndications or a smaller direct property investment. And if the investor does decide to borrow, he should gear into an imputation fund, rather than a house, as it is much more tax-effective.

Model three

This begins by spending $100,000 on fun and gratuitous wants, such as $50,000 on a new car and $30,000 on a few "toys" (a camera, home video and entertainment equipment and a small boat). The rest would be blown on an overseas holiday.

With all that out of the way, this investor would spend $50,000 to $100,000 on home improvements, keep $50,000 for emergencies and allocate another $250,000 for an apartment for his daughter. He says his plan would be to hold the apartment in trust in her name, and negatively gear it. He would rent the property out until his daughter was 25, which would ensure that she did not miss out on the trials of being a poor university student.

Another $300,000 would go on buying a low-maintenance home/apartment in Britain, one or two hours from London. The idea is that, after retirement, the couple would spend three or four months a year in Britain and the rest in Australia.

This investor would use, say, $200,000 to top up his super, provided it came within his reasonable benefit limit (RBL).

The leftovers could go into a blue-chip shares portfolio, preferably with a strong overseas weighting, and/or a well-located residential rental property. He says he would investigate whether he should invest in a separate superannuation fund for his wife, even though she is the beneficiary of all his assets, except for a cash legacy to his daughter.

The first $800,000 could all be classified as lifestyle decisions, and while there is an investment element to the property asset, this should be acknowledged.

Despite Dickson's reluctance to allow windfall investors to be totally serious with their initial round of investments, she says cars and toys are not investments; they are depreciating assets.

"If any of these is specifically for retirement, the purchase should be postponed until retirement, by which time they will get twice the technology for half the cost."

Although the investor is magnanimous to buy an apartment for his daughter, it could go wrong if not properly planned. Dickson asks whether the daughter will be the beneficial owner or only have the use of the property, and what degree of control, if any, does the investor have.

There are capital gains tax (CGT), stamp duty and other implications associated with these decisions, and getting the benefit of negative gearing would involve borrowing to buy the apartment, rather than using their own funds, and would require surplus income to service the loan.

Similarly, the investor would need good tax advice before buying an apartment in Britain.

She says Australian citizens' worldwide income is subject to tax in Australia, so any income from the rental property would need to be declared here. Australia has a double-tax arrangement with Britain but the investor needs good advice on the CGT implications.

With the remaining $1.2 million, the investor should consider what is to be invested inside and outside the superannuation structure, and every effort should be made to split the investments between the husband and wife so that on retirement their incomes are roughly the same.

A combined asset allocation for superannuation and non-superannuation investments should be determined - using mostly managed funds with perhaps some direct Australian shares and fixed interest - and the relevant investments then made in superannuation or their own names, according to tax effectiveness.