For those of us who are gainfully employed (yay), this is also often the time of year when it’s common to see overtime, raises, and bonuses (double yay). If you’re lucky enough to be one of those, it can be challenging to figure out what to do with that windfall, especially if you tend to second-guess yourself on the obvious, like I do.
It always seems like a good idea to put extra cash towards existing debt and overdue bills, and that’s often the case. Getting current on what you owe is usually the best first step when you finally have money beyond what you need to keep the lights on. Late fees eat away at meager resources, and stopping the bleeding there is vital. After that, though, the classic route is to start paying down your smallest debts. That does work, but you might also want to keep in mind what your highest interest rates are, as well as your shortest-term loans. Maintaining minimum payments on all of your bills, paying as much as you can on the lowest balance, and once that’s paid off, rolling that same payment into the next-lowest balance is called the snowball method and has a lot of psychological benefits to drive success. However, there are also psychological (and financial) benefits to choosing another debt to pay off first. The key is to have a plan and to stick with it instead of bleeding off some of your budget earmarked for debt for something else every month.
Sometimes, paying off debt isn’t the wisest financial choice. If you’re not behind and the interest rates are low, you might be better off putting some of that extra money into savings. If you don’t have an emergency fund already, now would be a great time to start one or top it off. The general rule of thumb is to shoot for at least three months’ of living expenses in a bank account that you don’t touch outside of true emergencies. You might need more or less, depending on your circumstances. It might, for instance, be wise to have a separate fund if you know that your car is on its last legs or if you are anticipating major repairs to your home anytime now. If you have big expenses coming up, you might want to save separately for them as well – things like an upcoming move, school fees, medical costs. Or if you know that you can slash your budget if you lose your job or can rely on external support, your calculation of “three months’ living expenses” might be lower than what you need today. Having that emergency fund can help keep you from falling behind on debt when you are unable to work, so it’s necessary to balance getting as much of it paid off as you can and being able to keep paying it if your income goes away tomorrow.
If your extra money is coming in the form of a raise, one of the best ways to pay off debt and increase your savings if your income is already meeting your usual expenses is to direct your raise at those goals. It will be like not getting a raise at all, for your everyday life. Behind the scenes, though, your financial security is increasing with barely any effort on your part. It’s one of the best strategies for long-term payoffs and savings too, like retirement funds and very large purchases – think school loans, houses, and cars. Your regular budget doesn’t change at all, and your standard of living remains the same, but you’ll inch ever closer to your goals. Think about how much more satisfying that can be, over spending your new raise on a new monthly luxury.
But don’t forget to set a little aside for that bit of self-care and spoiling yourself. Enjoying the fruits of your hard work shouldn’t be reserved for meeting long-term goals. The trick is to find something that doesn’t eat up all of your gains, so you don’t end up just treading water again after you’ve had your splurge. It might help both your determination to not spend it all and your guilt for using any of it for something frivolous to use that bonus to get a nicer version of something you already needed to buy, or to upgrade an experience you’ve already budgeted for. You’ll still be able to do something nice for yourself that way, while spending a little less than you might otherwise. I also like to have a few “bonus goals” in mind so that I can think in advance what kinds of splurges I might like should extra money appear in my life. That way, I can pre-budget for them, and talk myself out of truly unreasonable ideas that might be more appealing in the moment that check arrives. And hey, don’t forget: sometimes the most rewarding way to spoil yourself is to spoil someone else in your life.
I know we’re not all in the financial and life situation to have the first-world problem of more money than we need today, but we can get there. Part of it is learning how to figure it out, just like this. You’ll get there. I have faith.