How to spend that end-of-year bonus
If you receive a small windfall at the end of the year for whatever reason, you might be wondering how best to use it.
The end of the year is a time of gift-giving and receiving for many of us, but these rewards don't just come from friends and family. Many U.S. employees also receive a bonus in December, whether as a reward for exemplary work over the last 12 months, or simply a kind gesture in the spirit of the holiday season. While many workers may be expecting a bigger paycheck just before the New Year, plenty of employees receive extra compensation throughout the year. According to the U.S. Bureau of Labor Statistics, in 2016 supplemental compensation comprised more than 3 percent of total wages in both the civilian workforce and the private sector. That means the average worker could expect about $1.16 per hour in bonus compensation throughout the year.
Depending on your own financial situation, you may plan most of the year's spending around expected bonuses. But if you receive a small windfall at the end of the year for whatever reason, you might be wondering how best to use it. If you have some wiggle room in your budget, use this end-of-year bonus to get your finances back on track in the New Year.
1. Contribute to savings
Between the gifts for friends and family, traveling to far-flung destinations and routine expenses, December can be a financially stressful month. That's why it's no wonder the first instinct upon receiving a work bonus would be to splurge on clothing, a fancy gadget or a night out. There's nothing wrong with spending money on fun once in a while, but first, make sure your savings are up to par.
Suggestions on exactly how much to save vary widely, anywhere from 5 percent to 30 percent of your monthly income. You might not need that much, but it's smart to at least establish some savings for an emergency fund. Also known as a rainy day fund, this should be a sizeable amount of cash in an easily accessible savings account, which can then be tapped for unexpected expenses. Your emergency fund doesn't need to be reserved only for the most dire situations, either. Car repairs, doctor visits or parking tickets could all qualify for a rainy day withdrawal. If possible, contribute some or all of your year-end bonus to your emergency fund, and give yourself the gift of peace of mind.
2. Pay down debt
Most of us have debt in some form, and that's not always a bad thing. Buying a house or a car usually means taking on some debt to help accomplish these goals. But certain kinds of debt end up being very costly yet provide little reward. Credit cards and personal loans are two common sources of particularly expensive debt, since their interest payments are often much higher than most mortgages or auto loans. For example, a new homeowner can expect to pay around 4.5 percent in interest for a mortgage, but nearly 20 percent on credit card debt. As with any debt, the longer it remains unpaid, and the larger the total balance, the more it ends up costing.
If you are stuck in a cycle of high interest debt but OK on urgent expenses, use your bonus to pay off that debt, starting with the biggest interest rate. You'll quickly find that even one opportunity to "catch up" could make a major difference, and save quite a bit of money over time. If your only debt is of the lower interest variety - like a mortgage or auto loan - there's no harm in putting extra cash toward this as well.
3. Start investing
Let's say you're living the nearly-perfect scenario: A stable income, little to no debt and a savings cushion that could last at least a few months. You may think it just as well to cash out your year-end bonus in singles and drop them over a densely-populated urban area, instead of parking it in a savings account. While that would be very nice of you, don't fuel up your helicopter until you have a look at your progress on other essential financial goals like investing.
First, give your retirement savings a pulse check. A 401(k) or IRA fund is an excellent way to begin charting your long-term financial goals, as well as trying your hand at investing. If you're younger than 50, you can put up to $18,000 in a 401(k) per year, and no more than $5,500 in an IRA.
If you're on track for a comfortable retirement and still have a bonus to burn, you could give riskier investments a shot. As Nerdwallet explained, it's possible to dip into investing in individual stocks and bonds with as little as $500, but only if you're fine with losing all of it in a worst-case scenario. While 401(k) funds and IRAs also invest in the markets, this money is spread across numerous assets and professionally managed. Buying your own stock, however, involves much more risk, along with additional fees. Look for a brokerage with no minimum and take care not to let your cash savings dry up. Investing involves taking some big risks, but the rewards could be even bigger.
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