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 in to 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 already had 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 it’s 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 is 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 a 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 diming 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 – It’s 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.
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 any lasting impact from these cash influxes. The one and 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, but instead, I spent the money like it was going out of style and now I’m left with nothing to show for it.