Making the most of your Bonus

March 15 12 Comments latest by One Million and Beyond - » Weekly Review – March 23, 2008

This is a guest post by Matt, from OneMillionandBeyond.com. Matt’s goal is to reach a million dollars in assets by his 35th birthday… he’s starting by getting out of debt.

You log into your bank account to see a pleasant surprise: your bonus has come in! You’re one of the many people out there that gets a bonus from your job and it’s come in. Visions of big screen TVs and vacations swim through your head. Or is it all of that looming debt you’ve got? Regardless of what you are going to do you are now in possession of some extra money that you’re going to have to do something with.

If this is a regular occurrence for you then you might have already spent the money. I know that when I got a bonus from work I was either counting on it for something or I had already a plan to spend it. Regardless that bonus was pretty much as good as gone no matter what I ended up spending the money on. I’m sure that I’m no different than most people who get a bonus as part of their pay. The money comes in and then just as quickly its gone leaving us to wonder what happened to it.

Extra money comes into our lives from time to time and there are both things that we should do with it and things we shouldn’t. We’ll look at examples from both sides hopefully catching a few people out there and saving them some money in the process.

What to do

The list of things that you could do with a bonus are pretty much endless, from a $50 to a $10,000 bonus. Depending on your financial situation here are a few of the obvious choices for spending our bonuses:

-Pay down debt – A cash windfall is a great way to get ahead of the game

-Get caught up on bills – This one should come first

-Pay off loans – Bonuses can be a great way to get rid of loans and credit cards in one fell swoop

For example a few years back I got a $7,000 bonus, which I used to pay off a loan, that I had a little over year of payments left on, of about $3,500. This helped me out greatly by removing around $300 from my monthly expenses. It was a challenge not to take a trip with that money but by doing this I increased my cash flow for those 12 months, which made my life easier since I was living paycheck to paycheck at the time.

Now if you’re already ahead of the game and you’re not heavily in debt you’ve got a few more options open to you. First off I would set the money aside to keep yourself from nickel and dimeing it out of existence. The next thing I would do is set a part of it for yourself; you might as well reward yourself for your hard work. At this point you’ve got some options:

- Pay down the mortgage – This can save you thousands down the road

- Put the money into retirement savings – You might be able to save some extra money on your taxes if you do this

- Build up an emergency fund – If you’ve got one great, if not this is the best place to start

- Invest the money – Aside from retirement investment this could be a great way to start an investment portfolio

Using my previous $7,000 bonus as an example if I had used $4,000 of that money to pay down my mortgage the impact on the long term to my interest costs would have been enormous. Without getting into the dollars and cents of it that $4,000 can save you 10’s of thousands of dollars on your mortgage.

What not to do

The biggest problem in my opinion with bonuses is that you all of a sudden have all this extra money to spend. That vacation to Thailand all of a sudden becomes possible as does that big screen TV but that doesn’t mean we should spend the money this way. A few things that you should avoid when it comes to bonuses:

-Big ticket purchases – Blowing all of the money at once won’t help anything

-Not setting the money aside in some way – Its likely to vanish very quickly

-Splurge spending – You might be hitting the Visa before you know it

- Expecting it to last longer than you think – Because you have it doesn’t mean you need to spend it.

I know this part of the post doesn’t sound like fun but a bonus or unexpected money has this habit of vanishing very quickly. Not keeping an eye out for it can put you into some hot water if you’re not normally careful with your money. Keeping your lifestyle generally the same while getting the money to work for you will have a long term impact far beyond the benefit a big screen TV will ever bring you.

My Experiences

I’ve gotten bonuses and cash windfalls a few times in my life and pretty much every time the money vanished very fast. Each time I managed to pay down some debt before it completely vanished but there was rarely and lasting impact from these cash influxes. The one any only time I spent a massive amount from a bonus and been extremely happy about it was getting an engagement ring for my now wife. Other than this every single time the money was typically gone within a matter of weeks. I changed my spending for that short period of time while I had the money and now years later I can remember the ring and paying off a loan; the rest of it is a mystery.

Treating yourself to something is a nice way to spend part of it but if you don’t pay attention the money can be spent very quickly. Bonuses by nature are infrequent and we’re just not used to them (at least I wasn’t) so we spend the money as if it were our regular pay. To further illustrate how beneficial something like this can be had I invested my bonuses, when I was getting them regularly, I could have paid off all of my credit cards or put a small down payment on a house. Even if I had left the money in an ING type account I could have made thousands in interest by now. Unfortunately because I was careless the money vanished and if you’re not careful the same thing can happen to you.

If you’re lucky enough to get a regular bonus treat the money with respect; save some of it and let the power of compound interest go to work for you. Remember a $2,500 investment at 4% in 10 years is over $3,700, which translates to free money. That same $2,500 each year adds up to a whopping $31,000 after 10 years (at 4%), which is over $6,000 in free money. If you’re not able to set it aside for investment this is a great way to boost yourself out of debt quickly. A bonus should be treated as something separate to your regular income, which can help you maximize it one way or another without seeing it vanish before your eyes. By keeping my lifestyle and spending the same I could have made a huge impact to my life now but instead I spent the money like it was going out of style and now I’m left with nothing to show for it.

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12 Comments latest by One Million and Beyond - » Weekly Review – March 23, 2008

How To Not Lose

March 14 14 Comments latest by JaM

Eliezer Yudkowsky joins us from Overcoming Bias, an econblog devoted to human rationality and the cognitive psychology of mistakes. And if you think that’s interesting, you should see his day job.

Everyone thinks they can win.

Cognitive psychologists call it the Lake Woebegone effect, after the fictional town where “All the women are strong, all the men are good-looking, and all the children are above average.”

Four-fifths of drivers think they’re in the top third. Half of all sociologists expect to someday be among the top ten leaders in the field. Not a single US state will admit to test scores are below the national average.

Am I going to tell you that you’re not as good as you think you are? Well, maybe you are that good - I don’t know, I haven’t met you. That’s not the point I aim to make; not today, anyway.

But think, for a moment, about all the self-help books out there that can tell you - yes you - how you too can be amazingly successful if you just use their simple technique. Think about the stock-market investing books that promise that you, yes you, can be the next Warren Buffet. Or the entrepreneurial books, written by some fellow who cashed out back in the dot-com era, about how you yes you can be the next Bill Gates or Larry Page. And then there’s the gigantic industry in business books, telling every barista how to run the next Starbucks, and every janitor how to be the best CEO in the Fortune 500.

I call these books as “financial pornography”. And the information in them is, by and large, useless if you want to succeed in life.

It seems to me that every profession has a different way to be smart. A hedge-fund trader isn’t the same kind of smart as a research biologist. A corporate CEO isn’t the same kind of smart as a blogger.

On the other hand, the ways of being stupid verge on human universals. Casey Serin, a 24-year-old programmer with no experience in real estate, got himself $2.2 million into debt by lying on mortgage applications to purchase 8 houses in 8 different states. And that’s not even the sad part; the sad part is that afterward, he refused to give up. He went on spending money on real-estate seminars, and tried to take out a mortgage on a 9th house. He hadn’t failed, he’d just had a learning experience.

A good many CEOs could stand to learn from Casey Serin. It’s called the “sunk cost fallacy” in the literature - the tendency to throw good money after bad, because that way, you don’t have to admit you lost. When Lockheed finally abandoned the thirteen-year-old Tristar L1011 program, into which it had previously sunk $2.5 billion, its stock jumped seven and three-fourths points the day after the announcement.

Can you think of any politicians pouring more and more effort into a failing effort so that they don’t have to admit failure? That was the Vietnam War in a nutshell. Casey Serin has something to teach Senators and Presidents.

How about stock traders riding a losing investment into oblivion? There are people out there who used to trade billions of dollars, who could’ve stood to learn from Casey Serin.

The sad truth is that Warren Buffet can’t teach you how to be Warren Buffet. That kind of extraordinary success is extraordinary precisely because it can’t be taught. All those books of financial pornography about the superstars… ya know, if it was that simple, everyone really would be doing it.

There are winning tricks that everyone can use, yes. There’s “do repeatable experiments to test your beliefs” - an amazingly powerful technique called “science” that was successfully taught to others, hence modern civilization. There’s “invest your money to make more money” - you may not beat the market like Warren Buffet, but if you think about a whole civilization practicing that rule, we do better nowadays than historical societies with no banks or stock markets.

But the fact that there are a lot more scientists than Warren Buffets, should tip you off that Warren Buffet’s trick isn’t as easy to teach as the experimental method.

The really valuable information in life tends to be about how to not lose, rather than how to be a superstar. You’ve got more to learn from meditating on Casey Serin than from reading about Bill Gates. If you’re stuck in a lousy job, being mistreated and underpaid, you ain’t gettin’ out of there by founding the next Microsoft, no matter how hard you study the life of William Henry Gates III; but Casey Serin might teach you how to admit your damn mistakes and cut your damn losses.

But that kind of truth can be uncomfortable to face. It’s a lot easier to sell financial pornography, pleasant fantasies about how you yes you can be the next superstar, than to sell the truth: that you yes you are screwing up, big time, and need to change your ways.

Yes, I know someone has to be the next superstar. But the point is, they aren’t going to get there by reading financial pornography. And another thing: never think you can be a superstar without a lot of effort. You probably can’t beat the market at all - but you’re certainly not going to systematically beat the stock market in your off hours, without devoting your whole professional life to being a Super Investor. Indeed, one of the standard ways to Fail, which you can learn to avoid with only a small time investment, is thinking that you can cherry-pick the stock market.

Forget the pleasant fantasies, and study the history of catastrophe. Every time you read online about an Epic Failure, ask yourself, “What am I doing that’s like that?”

Want to be a great CEO? Don’t read about Microsoft, read about Enron - it’ll teach you something even if you never start your own company.

You can even study the systematic cognitive science of human error.

And maybe then you’ll get a chance to win - or more likely, live nicely but not as a superstar - but first, you have to not lose.

Eliezer Yudkowsky is still blogging at Overcoming Bias, just like when you started reading this. Little-known fact: In a random sample of catastrophic losers, the vast majority did not read Overcoming Bias. You too can learn from their mistake!

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14 Comments latest by JaM

Keeping Track of Your Tax Paperwork

March 12 16 Comments latest by GenPink | Tax Tips

Every year around tax time, I find myself scrambling to gather up all the little bits of information that I need to prepare our taxes. While it’s easy enough to collect up our various 1099 forms, W-2s, etc. as they arrive in January and February, we also have a number of business-related expenses, charitable contributions, etc. throughout the year. While I’m pretty good about keeping everything that we need, I’m not very good at keeping it organized. Thus, we run the risk of losing track of important paperwork and missing out on some legitimate income tax deductions.

Given that one of my main financial goals for 2008 has been to simplify our finances, I’ve recently spent a bit of time coming up with a simple, effective solution to this problem. In short, my new system is comprised of a few 9 x 12 clasp envelopes and a wicker basket. Thus far, I have envelopes set up for the following categories:

– Business expenses

– Medical expenses

– Charitable contributions

– Miscellaneous (mortgage-related paperwork, property taxes, etc.)

The basket lives on our kitchen counter and, whenever we incur a tax-related expense, I simply slip the receipt into the proper envelope and forget about it. Every few months, I’ll break out the medical envelope and claim those expenses against our flexible spending account (FSA). As for the balance of this paperwork, I’ll just let it accumulate until tax time.

I also have a “remote” version of this system that consists of a letter-sized envelope that I keep in my car for random tax-related expenditures while I’m out and about (mainly minor business-related expenses). I then periodically transfer these into the appropriate envelope in our main system such that nothing gets lost in the shuffle.

While I could probably further simplify this system — for example, by dropping down to just two envelopes (medical and other) — this works like a charm, takes virtually no time, and should save me a ton of pain at years end.

This is a guest post from nickel, who provides a steady stream of personal finance tips, tricks, and commentary over at FiveCentNickel. And since that, combined with his four kids, don’t seem to keep him sufficiently busy, he has recently launched yet another site, this time focused more narrowly on credit cards.

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16 Comments latest by GenPink | Tax Tips

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