…or get your tax refund.
Suddenly you have a ton of money! Yeah! But what do you do with it? You are my wise and clever reader, so you know it is not smart financial planning to blow it all on a sports car. But this new money isn’t in your budget, so how do you fit it into your spending and your goals?
First, you celebrate! It’s exciting, you have a little spare cash! Go buy that jacket you have been dying for. Try that new restaurant. Replace your ratty old gym clothes with something that makes you excited to exercise. Make the celebration reasonable- it should be about 10-20% of your new ca$h money. Spending $500 on a new tv when you got a $1000 tax refund might be going overboard, but maybe getting HBO might be a nice splurge.
Next- look at your debts and your savings goals.
- Can you pay off a credit card with this cash? Won’t that feel awesome, to not pay interest anymore?
- Is it enough to make yourself an emergency fund? Then you won’t have to worry about unexpected expenses, and the amount you were saving already towards your emergency fund can go to feed the general pot.
- Can you invest it in your 401k or your Roth IRA? Earn some crazy compound interest on this free money to make even more free money?!!
- Should you use it to pay off some student loan debt?
If I were you, I would do a mix of the things above with my newfound cash- but you have to be wise about it (consider your interest rates, my friend). If you can pay all of your debt off- do it! But paying just some of your debt off all in one big chunk may not actually be the best choice.
What if the cash you just received is big for you, but it is just a fraction of your overall debt?
Suppose you are the newly graduated Dr. John Doe. Medical school sure was fun, but the average cost of med school is $170,000. Your monthly payments are almost $2,000. Yikes.
But wait! An unknown- yet extremely wealthy- elderly relative just died peacefully in his sleep. He was so proud of his great-great-nephew the doctor that he left Dr. Doe $20,000.
If Dr. Doe immediately puts that $20,000 into the balance of his student loans, he will now owe $150,000. His monthly payments will be a little over $1,700. Is that much better for Dr. Doe, who may be struggling to make his rent while working those crazy shifts as a resident at his new hospital?
Depending on Dr. Doe’s income, it might be better to save the $20,000 and to use it to make the monthly payments. He can make 10 months worth of payments with the $20,000. The total interest he will pay will be slightly more than if he had paid a lump sum off at once- but not by much (an $8,000 difference). I suspect that early in his career, Dr. Doe would value 10 months of being able to pay his bills worry free more than he will value $8,000 after he is an established doctor.
Moral of the story: when you suddenly come into some money, think about your overall financial picture. Paying off part of your debts all at once might not make sense if you are struggling to make monthly payments- but if it lowers them enough to ease some of the burden, then go for it! Look at the parts of your budget that are difficult for you (maybe you just can’t quite squeeze enough cash into your emergency fund) and use the newfound money to help with those areas that are challenging.
Congrats on that lottery win, by the way!