Have you recently received a stimulus payment? Or a tax refund? Or perhaps a company bonus? This time of year is one of the most common to get a chunk of unexpected extra money.
In this article, we will discuss the best things to do with that extra money depending on whether you are in debt or not.
4 Ways to Use Extra Money
So what should you do with extra money? Here are four ways to use it based on your current financial situation.
1. No Matter What: Spend Some Money on Something Fun
Regardless of whether you are in debt or have hefty savings, I always recommend using some of your extra money to spend on something fun.
Whether it’s a fancy meal, a mini-vacation, or a shopping splurge, when you get a large amount of unexpected money, have some fun with some of it.
You will get more long-term happiness for experiences, so unless your shopping item is something that helps you experience more memories (perhaps a new bike), you’re better off spending it on an experience.
How much should you spend? Personally, I have a formula for how we allocate all extra money. No matter whether my tax refund is a few hundred dollars or if I were to receive a sizeable inheritance, I always use 10% of the money towards something I will enjoy now or in the near future.
As you customize your formula, choose a set amount, somewhere ranging from 10-15% of the total amount lump sum you are receiving, and allocate it as fun money
2. If You’re In Debt (Other than a Mortgage): Pay Down Your Debt
If you have consumer debt (like credit card, car, or other debt aside from a mortgage), you should spend the money you don’t use for fun to help pay down your debt.
Here is how I recommend allocating the remaining 90%: set aside 20%, establish an emergency fund, and then use the remaining 70% to pay down debt.
Your total equation looks like this:
- 10% – Fun Money
- 20% – Emergency Fund
- 70% – Pay Down Debt
Some might question using some of the money to establish an emergency fund when you have debt, but let me explain my reasoning. First, your emergency fund will provide some mental comfort. You will sleep better knowing that if you had an emergency car repair or home repair, you could cover it.
Second, it will help you avoid further debt. Again, if an emergency arises, you will be able to use your emergency fund rather than your credit card to cover the emergency.
Now, this approach isn’t for everyone. But, if you think the overall stability it will bring will help you, then use part of your unexpected money to start (or add to) your emergency fund.
3. If You’re Not in Debt: Maximize Your Retirement Savings
If you’re not in debt, the next best thing to do with your extra cash is to boost your retirement savings. But, besides saving for retirement, you should also consider putting some of the money towards a short-term savings goal (such as a house down payment, car, or fancy vacation) and some towards an emergency fund.
If you’re wondering how to add the money to your retirement fund when your retirement account is through work, here is a tip: increase your work retirement contributions for a period of weeks or months to allocate the appropriate amount of savings. Then use the unexpected funds in your bank account to cover your normal monthly expenses.
- 10% Fun Money
- 15% Short-Term Savings Goal
- 15% Emergency Fund
- 60% Retirement Fund
4. If You’re Not in Debt and Have Maximized Your Retirement Savings: Save for Other Long-Term Goals
If you’re in the favorable position of not having debt and you’ve already maximized your retirement savings, then what do you do with extra money?
First, you are entitled to spend a little more as immediate fun money. Then, think about what other short-term savings goals you have. Perhaps you want to take a few friends or family members on a trip to Europe? Or are you ready to remodel your kitchen? Or maybe you are saving for a sabbatical? Put the money aside for these short-term savings goals.
Lastly, you can open some other long-term savings vehicles like a true brokerage fund. No, these are not tax-advantaged to these plans, so ensure you’ve truly maxed out your tax savings plans first. Then you can put extra money aside for longer-term investment.
- 15% Fun Money
- 35% Short-Term Savings Goal
- 50% Long-Term Savings
The Bottom Line
Before you get unexpected cash, you should have a formula set for yourself so you don’t let the new money go to your waste. Use the formulas above that are best for your situation, then customize them as needed.