How to Budget Extra Money and Not Recklessly Blow Every Cent
Having extra money in your bank account is an awesome thing. You’ll probably feel like celebrating if you get a raise, pay off a big debt or receive a large financial windfall. But the question remains: What will you do with that extra cash?
It’s important to have a plan for extra money that falls into your lap, so you don’t recklessly blow through it. Take out your budget and assess your financial situation to see where an influx of cash would be most beneficial. Here are some smart suggestions for what to do with extra money.
1. Bulk Up Your Emergency Fund
Personal finance experts say you should have three to six months of living expenses in your emergency fund. That way should you encounter a major, unexpected expense or lose your job, you’d have a stash of money to tap into.
If your emergency fund is low (or nonexistent), use your new windfall to build it up. Keep this money in a liquid, no-risk account — like a high-yield savings account or money market account — so you can easily access it when needed.
2. Add to Your Sinking Funds
It’s likely you’re saving for multiple things at once — holiday gifts, your next vacation, home repairs and a down payment for a new car. Whether your short-term goals are ongoing or you have a specific dollar amount you’re trying to reach, your sinking funds can always benefit from more cash.
There are two ways to approach this. You could funnel a portion of your extra money to each thing you’re saving for. Alternatively, you can choose your biggest priority — think about which savings deadline is approaching first or which sinking fund could really use a boost — and put all the extra cash toward that goal.
3. Maximize Retirement Savings
Compound interest is the magic behind saving for retirement. You might not be thinking about the money you’ll need decades down the road, but you should be — and getting an early start means your money has more time to grow.
If you’re matching your employer’s 401(k) contributions, that’s good. If you’re investing at least 15% of your salary, even better. But maxing out your retirement accounts is the best move you can make.
The federal government places limitations on how much you can contribute each year to your 401(k) or Roth IRA. In 2019, the limit for 401(k) contributions is $19,000 for individuals under 50. If you’re 50 or older, you can put up to $25,000 into your 401(k) account. The Roth IRA limits in 2019 are $6,000 for individuals under 50 or $7,000 for those age 50 or older.
If your windfall allows you to max out — or simply add more to — your retirement accounts, this is a move future you will be thankful for.
4. Pay Off Debt
You know all those times you wished your student loan debt would be magically forgiven or you’d wake up to a $0 credit card balance? Your extra cash can be the answer to your prayers.
Two popular approaches to paying off debt are the snowball method and the avalanche method. With the snowball method, you pay off your smallest debt and then move onto your next largest debt and so on until you’ve paid everything off. The avalanche method involves ranking your debts by interest rate. You pay off the debt with the highest interest rate first and then move down the list.
Using your extra cash to pay off debt has added benefits. You’ll see your credit score increase as your credit utilization ratio (the amount of available credit you’ve used) goes down. In addition, once you clear your debt, you won’t have to budget for debt payments anymore. That means extra cash all over again!
5. Adjust Your Budget Allocations
Saving and paying off debt are fiscally responsible choices, but they aren’t exactly fun. When extra cash comes your way, it’s nice to treat yourself too.
Whether you’re regularly earning more money in the form of a higher salary or this is just a one-time surplus, look to your budget to see where you could use some extra dough.
Are you currently surpassing your spending limits in a certain budget category? Where are you feeling deprived? The answers to those questions may help you decide.
Maybe you’ve been stingy with your food budget and would like to buy the fancy cheese and expensive wine. Perhaps you want to add to your entertainment or clothing budgets.
If you’re wondering what to do with extra money, it’s okay to indulge, within reason. Just try to avoid lifestyle inflation — when you increase your spending to match an increase in income. Living below your means instead will give you a better financial outcome.
Nicole Dow is a senior writer at The Penny Hoarder.