Eagerly awaiting an end-of-year bonus or raise? Cheers! You’re one of the lucky ones. Extra income is always a welcome gift—especially during the holiday season. And yet, while a lump sum of cash can be a boon to your finances, more often than not, it can vanish as quickly as it arrives.
Where does it go? For many people, it seems to be a mystery. In fact, almost no one wants to talk about it—at least not to me! But I get it. I’m known to be a loud advocate of having a strategy for every penny of income. And while my approach may not be nearly as fun as using all of your bonus to splurge on a spur-of-the-moment vacation, the home-improvement project you’ve been dreaming of, or making Santa smile by adding a bunch of extra presents under the Christmas tree, I can pretty much guarantee that spending your treasure wisely will bring much more joy over the long term.
To be sure you make the most of this year’s bonus or raise, avoid these common mistakes:
- Assuming that paying off debt is your best option It’s easy to think that the first place extra cash should go is towards paying off outstanding debt, but that’s not always the case. Let’s say you are fortunate enough to receive a good-sized bonus. Putting that money toward your mortgage may sound like a great plan and the logical first choice. But consider this: if the interest rate on your mortgage is 3.75% (and if it’s not, we need to have a different conversation!), throwing the bonus at your principal at such a low rate will only have a marginal impact on accelerating your maturity date and/or reducing your interest paid. While the thought of a closer maturity date and less interest paid are nice perks, if the long-term expected rate of return of your portfolio is significantly higher than the interest rate on your mortgage, then investing that same money in the stock market has the potential to increase your one-time bonus significantly more over the long-term.
The takeaway: Before using your extra income to pay down debt, work with your financial advisor to determine the most appropriate option based on your personal financial situation.
- Opting for immediate pleasure over long-term satisfaction I’ve been hearing a lot about the book Atomic Habits on social media lately. While I haven’t read it yet (I hope to finally have time to dive in over the holidays), I follow the author James Clear on social media and recently caught this quote from the book:
“As a general rule, the more immediate satisfaction you get from an action, the more strongly you should question whether it aligns with your long-term goals.”
So true, right? It resonates in a lot of ways, but especially when it comes to spending. Will spending now give you immediate satisfaction? Sure. But I would also guess that whatever you purchase on a whim is probably not aligned with your long-term financial goals.
The takeaway: Consider spending just a chunk of your bonus on a December splurge, and working with your advisor to examine how to invest the rest to address your longer-term goals.
- Turning to the internet for ‘the answer’ Ah, the internet. Its ability to deliver information and ‘facts’ seems endless. But unless the guidance you’re reading is based on the details of your personal financial situation, online ‘how to’ tips on where to put your money could be all wrong—for you.
Here’s a great example: Last week, I received a question from a client who had read an article online that suggested opening a Roth IRA for a child and he wanted to know if he should open one for his infant daughter. Thankfully, he checked with a CFP® professional first! What I told him was that a child must have earned income to open a Roth, so his little girl definitely didn’t qualify. (He also wasn’t putting his own retirement planning first, but that’s a whole other can of worms!)
The takeaway: Deciding where to spend or invest your hard-earned bonus requires the guidance of a professional advisor who can guide you based on your big picture.
Now you know what not to do, but what are some wiser options to consider? Here are just a few ideas that are often at the top of the list for our clients. Of course, it’s always best to talk to an advisor who knows every nuance of your finances to choose the option that fits your financial needs and is aligned with your long-term goals:
- Estate planning In Indiana, the cost of completing a solid estate plan can be about $1,000. It’s a pretty small sum, and yet people often use that cost as an excuse to put it off—again. No matter how large or small your estate may be, that can be a big and costly mistake. If you don’t have an estate plan in place, consider making this a top priority.
- Disability insurance Disability insurance (or DI) is often ignored. Why? People have a hard time seeing the value in it. But according to the data, more than 375,000 Americans become totally disabled every year. That’s a scary fact when approximately 110 million Americans don't have long-term disability coverage. Even more, about 8 million adults have a disability that limits or prevents them from working. If you don’t have it, get it!
- Retirement savings If you’re receiving a raise (now or at any time during the year), consider increasing the percentage of every paycheck that you contribute to your retirement savings—either through your employer or via your personal IRA or other retirement account. In addition to boosting your retirement savings, this strategy can help prevent the dreaded ‘lifestyle creep’ that can thwart even the best-laid savings plans.
- Spend it! Of course, I’m not saying that you should spend all of the bonus or pay raise that you receive. But, as Kyle Thompson noted in his June blog Plan for Tomorrow, Live for Today!, it’s unsustainable for most people to save every penny that they earn and there should be room in your financial plan for you to enjoy the fruits of your labor responsibly.
Bonuses and raises are a great way to close out the year. Just remember that how you spend that gift—no matter how large or small—can make the difference between short-term satisfaction and long-term financial confidence. Talk to your advisor before you spend to be sure you make every dollar count.
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Are you wondering how your raise or bonus could be used to help you reach your financial goals? Give me a call to talk through your personal situation!
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