While it can be tempting to splurge on the latest bit of technology or treat yourself to an extravagant holiday, excessive spending may not be the most productive way to handle your bonus.
Try to resist the temptation to simply spend it and instead, take the opportunity to get your finances in order.
Research suggests that there is only very fleeting enjoyment to be found in making large purchases. On the other hand, sensible use of bonus payments can have incredibly positive effects on your financial health and wellbeing.
Following these simple steps will help ensure you get maximum benefit from your hard earned bonus:
Spoil Yourself…a little
You have worked hard for your bonus so you deserve to enjoy some of it. Separate an amount to spend on whatever you want but try to limit that to around 20%.
Pay down Credit Card and/or Personal Loan debts
If you owe money on your credit cards or have a personal loan with your bank you should make repaying that debt your absolute priority.
This type of debt typically has very high interest rates (credit card interest is often over 20% per year) meaning that the debt can snowball extremely quickly.
Use your bonus to pay as much of this debt as possible – your future-self will thank you for it!
Build a buffer
If you are free of consumer debt your next priority should be to build a savings buffer.
This ‘emergency fund’ should be equivalent to 3 – 6 months of your monthly expenses. The more people that are dependent on your income (eg young children) the greater the emergency fund you require.
The purpose of these savings is to cover unforeseen costs such as emergency house repairs, medical bills, loss of employment etc.
Failure to build an adequate savings buffer will leave you unprepared and with little alternative but to take out short-term credit (see step 2) or take withdrawals from long term investments.
Both of these scenarios could seriously impact your financial health and should be avoided at all costs.
Your emergency fund should be held in cash deposits and be immediately accessible.
Invest for your future
If you have achieved steps 2 & 3 now is the time to begin investing towards your long term future.
Place as much of your bonus as possible into your investment account or pension and repeat this step every year. As the years pass you will start to see this compound up in value and in turn, bring your eventual retirement date closer.
As the graph below shows, a person who invested their bonus in the S&P 500 40 years ago would have seen it grow to a massive 50x its value:
Source: Invesco – A long-term approach to equity investing
Repeating the same investment annually throughout that period would have left that person in an excellent financial position today.
We can’t assume history will repeat itself but we can be pretty certain that investing in a globally diversified portfolio (ideally an index tracker or ETF to ensure that your costs of investment are kept to a minimum) will leave you in a hugely advantageous position in the future.
Repeat step 4 next year and every year after!
Just remember that investing is simple, it is managing yourself that is the hard part! You can find more on this in our article on Successful Investing.