A correspondent asked:
I’m getting a bonus from work; what should I do with the money?
Flush in Florida
If you are among the fortunate who find themselves with a cash windfall, perhaps from a work bonus or a tax refund, you have three choices:
- spend it
- save it
- repay existing loans
Don’t spend it — the psychic joy will be fleeting and you’ll have the lost the opportunity to improve your financial situation and create a good habit.
Should you pay down existing loans or invest the funds? Either is a good choice but I’d steer you toward paying off a loan before you invest the funds. Why? Simply put, repaying a loan is financially equivalent to investing the funds with a guaranteed rate of return equal to the interest rate of your loan. That’s almost always a good deal.
You may have some subset of outstanding student loans, credit cards, car loans, and/or mortgage. What is the best approach for deciding where to apply your windfall? Logic dictates that you pay the debt with the highest interest rate and that’s always sensible.
However, psychology also plays a role in personal finance and you may want to consider paying off one of your loans in full, even if it does not have the highest rate. With this approach, you’ll feel a well-deserved sense of accomplishment and create some positive momentum.
If you pay off a loan, don’t spend the savings. Instead, start paying extra on the loan with the next smallest balance so you can more quickly pay off another.
If you have no loans, the best savings option is almost always contributing the windfall to a Roth IRA.
If you’re ineligible for a Roth IRA, the next best option is usually a 529 college savings account for your kid(s) or grandkid(s). These funds are tax-sheltered similar to a Roth IRA and there is flexibility for how and when the funds are used.
If neither paying off a loan nor investing in a Roth IRA or 529 account are options for you, then invest the money in a taxable account.
But, do it ASAP before you spend it.
Questions about your windfall? Get in touch.
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