Whether you got a nice bonus at work, an unexpected inheritance, or sold something of value, coming into some extra cash can be an awesome thing.
However, it also means you have a decision to make–what to do with that money?
Before you start spending it, you might want to take a moment to come up with a plan for how to use this lump sum of cash. Otherwise, it might just get frittered away here and there without making much impact.
There are lots of options for making the most of an influx of money–from beefing up your emergency or retirement fund to putting it towards something big that you’re saving up for.
What’s best for you will depend on your current situation, as well as your short- and long-term financial goals.
Here are a few ideas for making the most of a small (or large) windfall.
Padding Your Emergency Fund
If your emergency fund is low (or nonexistent), you might use your new windfall to build it up.
Having an emergency fund gives you a financial cushion, along with the sense of security that comes with knowing you can handle a financial set-back (such as a job loss, medical expenses, or costly car or home repair) without hardship.
Having this buffer can also help you avoid having to rely on credit cards for an unexpected expense, and then falling into a negative spiral of high interest debt.
A general rule of thumb is to keep three to six month of fixed expenses in cash as an emergency fund. Two-income households may be able to protect themselves with three months of savings. If you’re single, however, you may want to aim closer to having six months of living expenses saved up.
These options typically offer higher interest rates than a standard savings account, yet allow you to access the money when you need it.
Increase Contributions to Your 401(k)
Does your employer offer a 401(k) with matching contributions? If so, this can be a powerful tool to help you save for retirement.
Not only does a 401(k) help lower your taxes (since this money comes out of your salary before taxes are deducted), your employer’s matching contributions are essentially free money, and can provide a nice boost to your retirement savings.
If you’re not currently taking full advantage of matching funds, you may want to adjust your contributions to help ensure you’re making the most of this benefit.
Starting a Retirement Account
What do you do if you don’t have a company plan, or you’ve hit your contribution limit there? You might consider using your new influx of cash to open up (or add to) an Individual Retirement Fund (IRA).
While retirement may feel a long way off, starting early can be a smart idea, thanks to the magic of compound earnings (that’s when the money you invest earns interest, that interest then gets reinvested and also earns interest).
There is also a possible immediate financial benefit to investing in an IRA: Just as with a 401(k), your IRA contributions can possibly reduce your taxable income, which means that any money you put in this year can lower your tax bill for this year.
You’ll want to keep in mind, however, that the federal government places limitations on how much you can contribute each year to retirement funds.
Paying Down High Interest Debt
While mortgage loans and car loans tend to offer lower interest rates since they’re secured by collateral, the same can’t be said of unsecured debts, such as credit card balances, student loans, and personal loans.
If you carry any credit card or other high interest debt, you might want to use your windfall to jump-start a strategic debt payoff plan, such as the debt snowball or the debt avalanche method, in order to pay it off as quickly as possible.
With the snowball method, you pay off your smallest debt (while paying the minimum on your other debts). Once that balance is paid off, you take the funds you had previously allocated to your smallest debt and put them toward the next-smallest balance. This cycle repeats until all of your debt is repaid.
The avalanche method involves ranking your debts by interest rate. You then put any extra money you have towards paying off the debt with the highest interest rate (while continuing to pay the minimum on other debts). After the balance with the highest interest rate has been completely paid off, you move on to the next-highest-interest-rate balance (again, putting as much money as you can toward it), and then move down the list until your debt is repaid.
Using your extra cash to pay off debt has added benefits. You may see your credit score increase as your credit utilization ratio (the amount of available credit you’ve used) goes down.
In addition, once you clear your debt, you won’t have to budget for debt payments anymore, which is essentially getting extra cash all over again!
Saving for Personal Goals
If you already have a solid emergency fund, you may want to think about what large purchases you are hoping to make in the next few years. That could be a new car, a down payment on a home, doing a renovation project, or going on a family vacation.
A lump sum of cash can be a great way to jump-start saving for your goal or, if you’re already saving, to quickly beef up this fund.
For things you want to buy or do in the next few months or years, consider setting up a separate savings account that is safe, earns competitive interest, and will allow you to access the money when you’ve reached your goal.
Keep in mind, though, that with a CD, you typically need to leave the money untouched for a certain period of time.
Investing The Money
A little windfall can offer a nice opportunity to buy investments that can possibly help you create additional wealth over time.
For long-term financial goals (outside of retirement), you might consider opening up a brokerage account.
This is an investment account that allows you to buy and sell investments like stocks, bonds, and funds like mutual funds and exchange-traded funds (ETFs).
A taxable brokerage account does not offer the same tax incentives as a 401(k) or an IRA, but is much more flexible in terms of when the money can be accessed.
Though all investments come with some risk, generally the longer you keep your money invested, the better your odds of overcoming any down markets. Your investment gains can also grow exponentially over time as your earnings are compounded.
While investing can seem intimidating, a financial planner can be a helpful resource to help you create an investment strategy that takes into consideration your goals and risk tolerance.
Wondering what to do with a lump sum of extra money is a good problem to have.
Some options you might want to consider include: setting up an emergency fund, paying down high interest debt, starting a savings account earmarked for a large purchase, or putting the money into your retirement fund or another type of long-term investment.
You can mix and match smart spending and smart saving to fit your financial situation.
Whether you’re saving for something specific or storing cash until you’re ready to invest, SoFi money can help you put your extra money (as well as money you already have) to good use.
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