Ok, so before you pass go, I need to share my approach when it comes receiving/earning a commission check, referral fee or bonus. I recommend putting aside 25 percent of the money. The tax obligation could be more or less than the 25 percent, so at least you’ll have planned for it, beyond ignoring its reality. (I was speaking with a very successful female entrepreneur about a year ago when she lamented the fact that she enjoyed the large volume of commission checks without planning ahead. Unfortunately, she was left with a hefty tax bill…of the six-figure variety!)
What You Shouldn’t Do With This Extra Money
I recommend being mindful of potential pitfalls and building better financial habits. When we come across a windfall, be it a Chanukah gift, inheritance or the lottery, the first question that comes our way from our friends and family is, “How are you going to spend it?” No one usually asks, “How do you plan on saving that money?” Or, “How are you going to have that money work better for you?”
Obviously, every person’s situation is different, as is the size of the bonus, but whether we are discussing a $400 or $40,000 bonus some basic suggestions apply. Of course, this advice comes with the caveat that it is always good to consult a financial professional regarding how to manage a lump sum influx of money.
1) Don’t spend it all without a plan.
2) Don’t count on these funds when you are making your budget or allocating how to cover financial obligations.
3) Don’t use the money as a down payment for something that will have recurring payments that will create a bigger financial burden well after the initial money was paid, i.e., home loan for renovations and car loans.
Things to Consider Doing With This Extra Money
Let’s not forget one of the golden rules of personal finance: “Live within your means!” It may not be a sexy concept but it helps those who are guided by this philosophy stay on a more stable and honest path. (Honest with themselves!)
1) Pay off high-interest debt such as credit card debt, private loans or Home Equity Lines of Credit. To demonstrate the benefits we’ll use David as an example. David receives a $2000 end-of-year bonus. First David socks away 25 percent to pay for taxes. Then he takes the $1,500 left and pays down his $20,000 credit-card debt for which he pays 23%. If you don’t think $1,500 will make a dent, think again. Do you know what David pays the credit card company each year in interest for having that $1500 balance? He pays them $345 (1500 x.23=345). Which means David just saved $345…He gets to keep this money instead of paying the credit card company. Now that doesn’t mean David is in the clear or has resolved his credit debt problem, but by bringing down the balance David alleviates part of his problem.
2) Save more for retirement. The earlier you save, the more time the money has to grow and compound. In this example, Aliza receives a $3,000 bonus. She put away 25 percent for taxes. She now has $2250 to save for retirement. Let’s say Aliza is 25 years old and has 40 years to retirement. Making an assumption of six-percent return, that $2250 invested for 40 years will become roughly 23K. However, let’s say Aliza got the “I’m too young to worry about retirement now” bug and waits until age 35 to save for retirement; that same $2250 invested for 30 years with a six-percent return will become 12K at retirement. Wow! The difference is over $10,000 just because she decided to wait. Lesson of the day, start saving early and you will reap the benefit of how time compounds your investment. (Disclosure: The six-percent return was not meant as investment advice or prediction, simply used to demonstrate an example.)
3) Bulk up your emergency fund. (See my 12/29/2016 Jewish Link of New Jersey Article for details on “Start Building an Emergency Fund.”) Don’t let this one throw you. You don’t need to put all your “found money” here, just some of it.
Lastly, Don’t Forget to Reward Yourself
You clearly earned this bonus or gift and deserve to pay yourself first by taking a piece of the action and splurging. Whether that means getting a massage, getting that decadent something that is usually out of your budget (for me that would be the Delmonico steak at Prime Grill), getting your nails done, adding to a collection or hobby, don’t forget to reward yourself.
I know what some of you may be thinking… “I can’t do that.” I’ve got bills to pay, college, camp and school tuition to worry about. All very true, but you work hard and sometimes it’s important to invest in yourself. Some of us feel like we’re standing in between two cars of a fast-riding express train, juggling life’s obligations and managing everyone else’s needs. There is no reason to feel guilty.
So you received a bonus. That’s great. Hopefully this article gave you some ideas to consider as you plan what to do with it. (Notice how I didn’t state “how you would ‘spend’ it”...)
By Ronn Yaish, MBA
Ronn Yaish, is Wealth Advisor and CEO of Yaish Financial Services, a New Jersey-based investment and wealth management firm. Ronn earned a master’s in Education and an MBA in Finance. He has been featured in Forbes, AOL Finance, Credit.com, GoBanking and US News and World Report. His goal is to educate and help clients “keep things simple” when managing their money.