Everyone gets a little extra cash occasionally – perhaps as a gift or a tax refund. In today’s uncertain economic environment, you should have a plan for dealing with your windfall before you receive it in order to reduce the temptation to spend it unwisely. Here are a few ideas:
Add to your emergency fund.
Everyone should have an emergency fund. Ideally, you should save three to six months’ living expenses in a liquid account, such as a savings account or money market fund. Then you will have a source of funds if an emergency, such as a job loss, strikes you or your family. If you don’t already have at least $1,000 in your emergency fund, I recommend that you add your unexpected cash to this fund. If you already have a good start on your emergency fund, consider the next suggestion.
Pay down debt.
Use your windfall to pay down non-mortgage debt. Eliminating all debt except for your mortgage will truly give you peace of mind and eventually free up cash for other financial goals. Use your windfall to pay down the debt with the highest interest rate, such as a credit card. Keep chipping away by paying off one high-interest rate debt at a time. Eventually, you will be free of the burdensome – and worrisome – yoke of debt.
Save for your golden years.
If you are debt free except for your mortgage, consider using your windfall to save for your retirement. Try to save as much as you can in a Roth IRA or a tax-deferred arrangement in order to maximize the compounding of your investment returns. If your employer offers a 401(k) plan, consider increasing your contribution at least enough so you are receiving the maximum matching contribution, and use your windfall cash for your regular monthly living expenses.
Use your head.
It is exciting to receive unexpected cash. And, it’s very tempting to spend it on a short-lived dream, such as a weekend away from home or a new car. However, having a plan in place for dealing with a windfall – even if it means that you are committed to saving only half of the amount – can help you stay committed to your financial goals. Eventually, your commitment will lead to long-lasting financial security.