Wondering What to Do With Extra Cash?
Bonuses. Insurance settlements. Divorce. Inheritance. Tax refunds. All of these are reasons you might receive money that isn’t part of your normal cash flow. If it's a significant amount of money, it could completely change your financial path--but what about when it's a more moderate amount that could go towards any one of your financial goals? How do you prioritize what to do with extra cash?
No two people’s financial priorities are exactly alike. But just to give some rules of thumb, here are a few questions to ask yourself when deciding which financial goals to tackle first.
Pay off debt or invest?
Remember the power of compound interest, or interest earned on interest. High-interest debt compounds quickly, and can threaten the rest of your financial picture.
But should you pay off all debts immediately? There is more to it than meets the eye. Where can your money benefit your net worth the most? High-interest debt (as mentioned above) can pose a significant threat to your financial stability because any debt you carry over from month to month can quickly grow and compound. But lower-interest debt that eventually becomes equity, or an asset (mortgage, auto, etc.), should not be as much of a concern as long as your total debt remains under about 30% of your take-home pay. If your debt is within acceptable levels, contributing toward investments could be more impactful to your overall net worth.
Do you have enough in an emergency savings fund / cash reserves?
Sufficient cash reserves protect you from emergencies, allowing you to “be your own bank” and avoid high-interest debt. We typically suggest saving 3 – 6 months of your core expenses, but this will depend on how you earn money. If your income fluctuates, be sure to build reserves equal to the lag time of inflows.
Are you maxing out pre-tax retirement accounts?
This reduces your taxable income. The pre-tax contribution limit for 2017 per individual is $18,000, plus an extra $6000 “catch-up” contribution for those over age 50.
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Do you have after-tax investments too?
It is crucial to have both pre-tax and after-tax accounts because both have different advantages and drawbacks. Workplace retirement accounts funded with pre-tax money allow your investments to grow tax-deferred, but you will eventually have to pay taxes on the withdrawals. Tax-deferred plans are drawn down much faster than after-tax plans for this reason. Because you have already paid the taxes on after-tax investment funds, this type of account gives you extra diversification and retirement security.
Can you make progress on college funding goals?
If college funding is a goal for your family, use a 529 plan with low-cost funds. The inflation on college costs is about 6% per year, so consider treating this goal much like you would a credit card balance and “pay it down” sooner rather than later.
The psychological side of “sudden money”
A very large financial windfall can have emotional repercussions too. Receiving a large inheritance, for example, can bring conflicted feelings, such as deep loss and grief combined with relief that you can meet certain financial goals. Some people may respond to large sums of money by trying to get rid of it as soon as possible so they don’t have to think about it—while others may feel analysis paralysis given all of the available options.
Sometimes the wisest thing to do is to take a time out. While of course there is an opportunity loss to keeping too much money in cash, if taking a “time out” will help you avoid a rash decision, it can be a positive move. Money doesn’t go bad, so don’t feel like you need to act immediately. Just make sure you set a “check-in” deadline for yourself to think about what you would like to achieve, and make a list. Taking some time to think may also spark an idea to earmark some of the money for a specific goal that would honor the source of the money, such as a charity donation, scholarship fund or event.
After you have time to collect your thoughts, sit down with an advisor. Make sure this advisor is a fee-only fiduciary who will make recommendations according to your best interest, and who can help you to prioritize your goals.
At Halpern Financial, we take a holistic view of your financial life to help you with decisions such as how to properly allocate a windfall. We are happy to answer your questions and listen to your concerns about the process. Please don’t hesitate to reach out if this situation rings true for you!
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Halpern Financial, Inc.), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Halpern Financial, Inc.. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Halpern Financial, Inc. is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Halpern Financial, Inc.’s current written disclosure statement discussing our advisory services and fees is available for review upon request.