Last month I received a small bonus from work and after the initial excitement of having some extra money as well as the appreciation and recognition for a job well done, I needed to decide what to do with it, as I didn’t want to blow everything in one go.
How could I make the most of it and allocate it in the best way possible to get bigger long-term results from it? Should I save it, use it to pay off debt, invest it or invest it in myself or my company to generate more income with it?
Here I’ve put together some key points that I hope will be of use to you for when you too find yourself with a little bit of extra money – maybe due to a (small) pay rise, a present or just because you’ve perfected your budgeting skills.
Here are some of the advantages and disadvantages of what you can do with some little extra cash:
Build an emergency fund
What: Save together $1,000 (or the equivalent in your country).
Pros: An emergency fund will allow you to pay for unexpected events without having to go into debt or eating into your savings. I also recommend to build a 6 months living fund with time to cover your expenses for up to 6 months if you find yourself without a job for a prolonged period of time.
Cons: Don’t put more than needed in this savings account, as it will likely not be making you any money due to low interest rates, so once you’ve hit your target amount, put any extra money elsewhere.
Pay off debt
What: Make an extra payment towards your debt, such as a credit card, mortgage or student loan, especially if you have any debts with an annual interest rate over 5%.
Pros: By reducing your outstanding principal, your interest charges go down and so will the long-term effects of compounding interest. The long-term goals of becoming debt-free also means more independence and peace of mind.
Cons: Paying off debt reduces your expenses in the long run, it doesn’t create more money. If you only have outstanding debts with a fairly low interest rate (4% or less), you might get a higher return-on-investment in other ways, such as investing it or generating another income stream with it.
What: Put the money in a savings account to generate interest.
Pros: It gets you a little closer to your savings goals and it will make you some extra money over time due to interest and most importantly: compounding interest.
Cons: Interest rates are extremely low at the moment and below most inflation rates which means that not only will that money sit idly without making you much money, with time it will also lose value.
Contribute to you pension
What: Make an extra contribution to your private or workplace pension plan.
Pros: By adding more to your pension you’ll not only increase your pension fund, it also allows for it to grow even faster due to increases in returns and its compounding effects.
Cons: Any money invested in your pension plan will not be available until your retirement, you essentially lose access to that money for a long time (or you might be able to take it out before but will need to pay hefty fees.)
Invest in a brokerage account
What: Invest the money in your own private investment account to generate interest and dividends.
Pros: Increase your investment funds, as well as the amount of dividends and interest generated to compound without losing access to this money.
Cons: You likely won’t benefit from the same tax advantages that pension funds give and you have to manage your own investments.
Invest in yourself
What: Invest in your individual capital by spending the money on a course, attending a conference or buying books to gain new knowledge or develop your skills.
Pros: Can be tailored to your needs and interest, and can have a long-term effect on your employability, professional development and / or earnings.
Cons: This strategy can be time consuming and prove difficult to see direct financial effect.
Invest in another income stream
What: Set up a company, write a book, buy a property-to-let or find a different way to create another income stream with time.
Pros: Can provide you with a reliable, steady stream of income on the side.
Cons: Can be expensive, hard work, uncertain and unsuccessful.
Which of the above options you ultimately choose depends on your current circumstances: your dreams, plans, job, how much money you have to spend, the risks you want to take, how much time you can and are willing to invest, your family situation and many more. I hope however that the above helps in giving you a better idea of the various options to help you make a decision!
In addition to using your money wisely, if you feel you want to also enjoy a little bit of that extra money now and not just invest it in your future, consider sticking to the 50% rule: invest 50% and keep the rest to spend freely on whatever you want now. Or adapt this to whatever % you want: invest 70% and keep 30%, invest 20% and keep 80%..Whatever you feel happy with!