Here’s a nice problem to have: What do you do with extra money?
Whether it’s your tax refund, a bonus, an unexpected stimulus check, a break on your student loan payments, an inheritance, a winning lottery ticket….what all of these have in common is that this is an unexpected, yet welcome addition of cash. It sounds like a dream, but figuring out how to allocate that extra money in a world full of competing financial obligations? Where do you even start?
Remember, there are 4 main action steps you can take with your money:
This is probably the easiest action you can take with your money. It’s the action step that people fantasize about. There are SO many possibilities!
Obviously, you want to make sure that your regular bills are taken care of. But how do you spend your money after taking care of your essentials?
It can fall under one of two categories: “responsible” spending and “fun” spending.
“Responsible” spending: You know that you should spend your money on certain things, like the responsible person that you are, but….oh look….squirrel!
Here are examples of “responsible” spending that are not a part of your day-to-day finances, but much like eating a balanced diet and getting enough exercise, these expenses are good for your financial health. Examples include:
- Paying off debt: You’ve covered your minimum payments, but now you have the ability to pay your debt off even faster!
- Tax Bill: Have a bigger than expected tax bill? Here’s your chance to take care of it without having to raid your savings.
- Insurance (life and disability): It’s so easy to put life and disability insurance on the back burner because they aren’t mandatory, such as home and auto insurance. But if you care about taking care of yourself and your loved ones, don’t forget about adding life and disability insurance to your financial plan.
- Estate planning: Talk about a subject that people really don’t want to talk about! But you have assets, and I’m pretty sure you’re going to want to have a say as to how those assets are handled in the case of your incapacity or death. So check this off your to-do list!
Discretionary (“fun”) spending: Ah- this is the sort of spending that people dream about when they win the lottery. Yes, some of these are considered “essential” expenses, but let’s face it- we could always spend more in any of these categories just for the fun of it! Here are some examples:
- Kids and pets
- So much more….
Yes- the choices are endless. You could easily blow all of your extra money in one single “fun” category.
Sticking extra funds into savings may not feel very satisfying, but your Future Self will really thank you for this, especially if you come across hard times and you need access to cash FAST. Not only that, but it adds much needed peace of mind.
A great habit to get into is to pay yourself first. Consider this an essential expense, just like paying your rent or mortgage. Here are examples of what you would save for:
- Emergency Fund: Remember, this is for emergencies, NOT for expenses that you know will be coming up. You can read more about emergency funds here.
- Short Term Savings (time frame less than 5 years)
- Down Payment on Home
- Baby/Maternity Leave
- Opportunity fund for business/real estate
- Tax Bomb for student loans (some people choose to invest for this rather than save- see below)
- Sinking funds for various known upcoming expenses, such as your annual premiums, semi-annual property tax bill, continuing education costs, summer camps, holiday spending, etc.
Saving and investing are different: saving is about the short term, whereas investing should be all about the long term. This is because the point of investing is to grow your money, and this needs to happen over a longer time frame (typically anything that will be 10+ years into the future). The key is to start early and invest often! Here are common investing goals:
- Retirement: Your workplace retirement accounts and individual retirement accounts are designed to help you save for retirement, as well as give you some tax breaks!
- Tax Bomb: You need to plan for that tax bill at the end of your loan term if you’re going for forgiveness. This is a 20-25 year time frame, which gives you a long investing time horizon.
- College: Again, assuming that you set up an account at birth, you’re looking at a long (18-year) time frame to save for college.
- Business/Real Estate: Investing is not limited to the stock market. You can certainly choose invest in business and real estate. As with any type of investing, understand the risks you’re taking before you dive in!
Finally, there is the option to donate your money. Although not a money action that everyone takes, including charitable giving into your regular budget as a way to feel connection to groups and organizations that you feel passionately about is a great use of your money!
Charitable giving is done when you feel called to do so, not when you feel forced to do so. Even as the tax code encourages charitable giving, this shouldn’t be the main driving factor behind your giving. Get in touch with what’s meaningful to you, then find a way to share your bounty with others.
PUTTING IT ALL TOGETHER
Assuming that you have all of your essential expenses taken care of, what do you want to do with your windfall?
Start with the high priority items first, such as “responsible” spending and padding your emergency fund if it’s not where you want it to be.
From there, look at the 4 action steps and write down your priority list of where you want your money to go. If being debt free is high priority to you, then focus your energy there. If saving for the future is a priority, focus your energy there. If you feel that pull to be charitable, then you know what to do.
Remember that every dollar has a job, and that this doesn’t have to be an all-or-none event. It’s not a bad idea to carve out a small percentage for “fun” spending so that you don’t feel like you’re 100% depriving yourself with this unexpected windfall! However you decide to use your money, it should always be in alignment with your needs, your priorities, and your values.
Have you come across a windfall lately? How have you decided to spend the extra money? Comment below!