Congratulations! You have an extra $1,000 in your account at the end of the month. Maybe you got some Christmas money, maybe it’s an inheritance from an uncle, or maybe you worked hard and saved it up. The question that many people face at this moment is, “What do I do with this money?”
So how do you decide what to do with that money? Assuming you haven’t decided to spend it already, there are many places to put the money. I am going to break down the three most common options. You could 1) Keep it in the bank, 2) Pay off debt, or 3) Put it towards retirement. The good news is, there is no right answer. The bad news is, there is no right answer. Some financial experts will swear by one choice and call you an IDIOT for doing anything else. However, unless you decide to take that money and go to the mall for that new wardrobe, you are not an idiot. I am going to make the case for each of these options based on some example situations.
Save it – You live paycheck to paycheck. Every month is a struggle as to whether you will be able to make that next rent/mortgage payment. Put this money in a savings account and pretend it isn’t there. It’s always nice to have some money to fall back on if something goes wrong. Another argument for saving it is if you want to save money for a big purchase coming up; a new car, a vacation, or a home. If it is a home, I would suggest taking the time to build up enough savings for a 20% down payment.
Pay off debt – Let’s say you are an average person with credit card debt, an auto loan, student debt, and a mortgage. You should pay off your credit cards. Credit cards normally have outrageous interest rates and you will be better off getting them out of your life. If you don’t have credit cards, maybe your student loans or auto loan has an interest rate over 5%. Debt can be a major burden on your life, so take the opportunity to pay off extra when you can.
Save for Retirement – You are debt free or very little debt with low interest rates. You are saving a little each month, but don’t have any major expenses planned soon. This is a great opportunity to add to your retirement. Use this money to open up or contribute to an IRA. The money you save early will grow over time to earn much more than if you wait 5 or 10 years. In the words of Albert Einstein, “Compound Interest is the 8th wonder of the world. He who understands it, earns it ... he who doesn't ... pays it”.
The important thing is to make the decision that your are comfortable with. Any one of these decisions could be best for you. Maybe you want to split the money between two options. That's fine! It’s similar to hitting a traffic jam and deciding to stay or take a different route. When you arrive at your destination, do you actually know if you chose the fastest route? No, but you made it to your destination and you were comfortable with your decision. The important thing now is to think about it so you have a plan when this happens to you in the future.
If you have questions or need help, feel free to reach out.
Mike Zeiter, CPA/PFS