Whenever you receive surplus funds or make a windfall, it’s important for you to know how to maintain the right balance between enjoying this money and allocating it smartly towards your financial objectives. (Photo: Reuters)
It’s April and many salaried persons would be expecting to be paid their annual bonuses and receive a pay hike. Whenever you receive surplus funds or make a windfall, it’s important for you to know how to maintain the right balance between enjoying this money and allocating it smartly towards your financial objectives.
You’ll often notice there are two types of people. One: whose sole objective is to enjoy their money and not bother with financial planning. And two: people who save and invest throughout their lives in the hope to enjoy it someday in the future.
However, in the ideal scenario, you should have the best of both worlds. Not only should you plan and invest for the future, you must also enjoy your money today as well.
When you receive your annual bonus and an appraisal after a long year of hard work, it is important that you evaluate all your options for using this money. It could be used for repaying loans, making an investment, buying a desired item such as a car, and so on. Each option must be carefully assessed.
Let’s take a look at some smart moves to make with your annual bonus.
Get ready for an emergency
Experts recommend maintaining an emergency fund to handle your fixed and variable expenses through a period of six to eight months. This emergency could be a loss of employment, a medical problem, an accident, damage to property, and so on. While many of these situations can be covered with insurance, it helps to have liquidity in an emergency. Basically, you must assume that there could be a situation in your life where your ability to generate a monthly income could be impacted. This is where your emergency fund would cover you.
When you get your bonus, have a look at your spending patterns over the last six to eight months. Evaluate the size of any existing emergency fund you may have and if it would have helped you get through those months. If not, you may want to top up the fund. The ideal instruments for creating an emergency fund would be recurring or fixed deposits, liquid mutual funds, and debt funds.
Check your insurance needs
Your insurance needs change in tandem with your family’s spending habits, income fluctuation, and rising inflation. People sometimes forget to reassess their life and health insurance needs with the passage of time. Using your bonus, you may look to spruce up your insurance coverage. Get a brand new cover if you so wish, or supplement the covers you already have.
Pre-pay your loan
We’re at a time where it’s advisable to pre-pay on your loans. The interest rates seem to have bottomed out; loans are also being offered at low interest rates. The yield on fixed income instruments such as bank deposits has also reduced. Therefore, having surplus income now is a great reason to reduce your loan balance through principal pre-payments. This has the potential to significantly reduce your interest payments in the long run. You may divert some of your allocation towards bank deposits towards pre-paying on your loan.
Doing this would not only reduce your long-term interest payments, it will also help you in the short term at any point the interest rates start rising again. Having made a pre-payment, the rise in EMIs would not pinch you as much.
However, if you’re nearing the end of your loan tenure, you may want to avoid pre-paying in order to maximise your tax savings through your home loan principal and interest payments.
Settle credit card dues
If you have any outstanding balance on the credit card or if you have taken personal loan, use your annual bonus to clear these debts on priority. These loans have some of the highest interest rates among all loan products, and clearing them off at the earliest is in your best interest. Delayed payments towards unsecured loans and credit card balances can also spoil your credit score, so do not take this lightly.
Reassess financial goal
Investment should be aligned to your financial objectives. When you get surplus income with your annual bonus and appraisal process, reassess your financial goals once again, and provision at least a part of your bonus towards those goals. With this increased allocation, you may be able to achieve those goals in a quicker time-frame.
What about your enjoyment?
You can distribute your bonus fund smartly between all your financial needs, and you can still allocate something towards your wants such as a holiday, or buying a car or new cellphone. Proper distribution of funds on the basis of financial priority would ensure that the money is not wasted and you are not deprived of the securities needed to enjoy life.
(The author is CEO, BankBazaar.com)