Most of us dream of winning the lottery, but there are times when smaller lump-sums come into our lives. What should be done with that extra money?
In my humble opinion, you should split that extra money in the following way:
- 50% to your investments
- 30% to your debts (if you have any)
- 10% to your emergency fund
- 10% to whatever you want
Investments need to be funded.
My advice is to invest money when you have money. Your Tax Free Savings Account and your Registered Retirement Savings Plan will not fund themselves. It’s up to you to put the money into both of these accounts. Once you’ve made the contributions to your TFSA and RRSP, you have to invest that money so that it can grow over a long period of time.
If you’ve already maxed out your TFSA and RRSP contribution room, then put the money into your non-registered brokerage account. The government taxes capital gains and dividends earned in your brokerage account less than it taxes income received from your employer. This is a very good thing.
So when that “extra money” lands in your bank account, invest half of it.
Pay down your debts.
In an ideal world, you don’t have any debts.
Most of us don’t live in an ideal world. Debt is a part of many people’s lives via student loans, credit card debt, medical debt, mortgages, car loans, etc… I view debt as a financial cancer. Debt prevents you from building your own financial cushion. It prevent you from accumulating wealth. When you send money to your creditors, then you’re unable to invest those same dollars for Future You. Debt limits your ability to make life a little bit easier for Today You.
So when extra money comes your way, send atleast 30% of that amount to your debts. If you want my opinion, pay off any debts that can be paid in full. I subscribe to the Debt Snowball method of repayment because it feels good to get rid of debt. Positive psychological boosts are generally good motivators, so I’m a fan.
Top up your emergency fund.
It takes a very long time to build up an emergency fund. While some people are comfortable with a smaller one, my goal is to work my way up to 12-months worth of expenses. I’ve yet to meet this goal and I’m still working towards it. Thanks to my automatic transfers, I’ll get there eventually.
In the interests of transparency, I’ll tell you that I recently had to pull money from my emergency fund. Accordingly, refilling my emergency fund has moved up my priority list for my money. I need my cushion to be replenished as soon as possible because there’s no way to know when the next emergency will arrive.
When extra money comes your way, it’s an extremely good idea to put atleast 10% of that money into your emergency fund. You don’t know when that emergency is going to land. There is a high likelihood that there will be a financial component to your emergency. Right now, there’s no way for you to know how big that financial hit will be. Trust me when I say that you will be very happy to have some money salted away the day that you have to deal with your emergency.
Spend the rest however you want.
That’s right. I want you to spend the last 10% of your extra money however you want.
While I firmly believe that it’s important to save for the future and to get out of debt, I realize that one of the main benefits of money is buying those things that will make you happy today. Is it a nice dinner out? Maybe a day on the links? Or you need to refill your wine-rack? Perhaps you want to upgrade your phone or your computer? Is there a getaway that you’ve been wanting to do?
Whatever it is, make it happen with the remaining money without going into debt.
Let your priorities guide you.
It’s your money. You’re the one deciding how to spend your extra money. My suggestion allocation of how to use that money is for those who might need help in figuring out what to do with their extra money.
Now, the allocation suggested above is just my preference. Other people might have different priorities for their extra money. Some people might want to put all that money towards paying off their debts. There are others who will put the whole amount into their investments. Of course, there are also those who will see this as “found money” and will choose to spend the entire amount on whatever they want at the moment.
Do what makes sense for your life. Having a plan for your extra money ensures that your priorities are met, and that you’re not left wondering where all that money went.