Making the most of your Bonus

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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

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  1. Editing = good mojo

  2. I actually can perfectly relate to this post. I have gotten 2 large windfalls and now one relatively large bonus in the last few years and I have to say that setting the money aside and not blowing it immediately seems to be pretty much the key to a future well being.

    I am slightly OCD with my money management, but it pays off handsomely. For example:

    I have approximately 8 different accounts within ING that are all used for a specific purpose. Some of these include funds for “taxes and insurance”, “stock market” (accumulates cash to invest), “future engagement ring” (starting early so it won’t be a pain later), ” and “vacations”, amongst others including an emergency fund that I started first and just recently completed filling up to about 3-4 months of living expenses should the need occur.

    A windfall and/or bonus is a perfect opportunity to set aside money into accounts you’ll need to draw on later, meaning your future cash flow from your paychecks will go on uninterrupted as you merely fund your future expenses with you money you set aside at the time of a bonus!

  3. Good post but the last part is slightly misleading. The interest on your savings account isn’t completely free money. You’ll get taxed on that amount as income. If you already have a sufficient emergency fund established, you’re leaving a lot of money on the table by not diverting funds into tax advantaged accounts like your 401k, Roth IRA, and my new favorite the Roth 401k.

    I know too many people who stash away tons of money in their money market savings accounts because they are afraid that something catastrophic will happen. The advantage of the products mentioned above only magnifies if you invest more money sooner. If you are retiring in a year, the difference is negligible. If you’re retiring in 30 years, the difference is VERY significant. The tax savings compounds too!

    divad smot – slightly OCD sounds like an understatement!

  4. I just inherited some money, so this is an extremely pertinent article. I had discussions with my parents over whether to pay off my car loan (I have 5600 left on it), or invest the money. that was when I thought I’d be getting 5,000 dollars, but I’m really getting 9,000. I suppose now, I get to have my cake and eat it too. And by cake, I mean “increased cash flow from my employment income” and by eating it, I mean “investing my inheritance and paying off the car loan with it as well”.

    No splurges for me!

  5. Wrote a related post about some high-flying sales reps … my advice: INVEST 50% of any pay rises (all the ways that you list are good choices) and SPEND 50%. Why not save it all? There’s such a thing as TOO MUCH delayed gratification … it’s important to reward progress in a small way now … with the big reward (when the invested 50% compounds) later!

    Great post … thanks!

  6. I get a Christmas bonus at my job. It’s never very big and goes straight to my credit cards. My roommate on the other hand get very large bonus checks and always blows them on TV’s or surround sound systems. I guess its just a matter of personal preference, but I always think to myself that I could do so much more with those checks.

  7. You need have fun with some of your bonus money. Last year, I saved 80% or so, and spent the other 20%. According to my MS Money history, the fun money was spent on jewelry and a professional massage.

    Now that silver is up so much, do I count that necklace set as an investment? Does this mean I need to re-attempt blowing some fun money? ;-)

  8. The defining feature of a bonus is that it’s a lump sum. Lump sums are hard to come by, and generally should be preserved as such. I would reduce this entire topic to an axiom: PRESERVE THE LUMPINESS OF LUMP SUMS. Put it somewhere and think about it, admire its lumpiness. It’s your wealth, and it’s a symbol of your ability to build wealth. Think about what to do with it over time. In the meantime, you will be very proud of yourself for having such a tangible symbol of your current wealth, and psychologically you have taken a true step towards permanent security.

  9. I disagree about the “Payoff your mortgage” part.
    2 reasons:
    1. If I have a 5.75% mortgage rate and can earn more than that by investing the money in other securities than I have positive carry and paying off the mortgage is not a great idea.
    2. What about deducting my monthly interest oayments from my taxes?

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  11. Great post! As a financial advisor to young America, I always hold my breath when one of my clients gets a big fat check. Will they blow it? Or take this rare chance to get a huge jumpstart on their financial life? Thanks for providing some tips.

    Along those lines, check out a new blog I just started posting to called MoneySmartBlog.com that discusses a lot of these issues. I actually just wrote a post about using your tax refund to improve your financial life. I’d love to hear your thoughts!

  12. [...] had a guest post on Ramit’s blog, I Will Teach You To Be Rich, which was an amazing experience. I’m going to see if I can get a [...]