A friend was expecting a nice bonus at work. So, he reached out and asked for investing advice… but there was a bigger problem to tackle first. This friend falls prey to what holds most people back from reaching financial freedom.
I found out through the grape vine that he’d already spent his bonus income before receiving it. Then when the bonus came through, it was lower than expected.
Now, it’s great that he reached out about investing… but instead, he should have asked how to spend the bonus wisely. A bonus or salary bump can reduce financial stress in the short-term and improve relationships. It can also increase your ability to buy more down the road. To find out how, I’m going to show you some examples and how I personally spend my bonus income.
How to Spend Your Bonus to Reduce Stress
One of the best ways to spend your bonus is to pay yourself first. Now, if you’ve borrowed from your future self (aka taken on debt), it’s almost always best to pay that off first. When you pay back borrowed money early, you can lower the total amount of interest you pay. So that’s more money in your pocket.
Another great way to spend your bonus is by starting an emergency fund. Putting bonus income towards an emergency fund can reduce stress. Almost half of Americans wouldn’t be able come up with $400 to cover an emergency expense. And that’s not a lot of money. One unexpected trip to the doctor can easily top that amount.
I personally have six months’ worth of expenses saved up in my emergency fund. That way if I lose my job or other big expenses come up, I’ll be less stressed while figuring things out. If something like that happens, this will also make me less of a burden on my family and others in my life.
Sure, it feels great to buy nice gifts for others. But there’s a reason airplane safety videos tell you to put on your safety mask before helping others. Once you’ve helped yourself, you’ll be able to more sustainably provide for others.
Most financial stress in America is avoidable with a frugal mindset. I see a lot of bad money decisions firsthand and I could bore you for weeks with economic data to back it up. But I’ll just give you one big example today. It shows the impact of bad spending habits.
There is a negative correlation between the cost of weddings and the duration of marriage. Couples that spend more on their weddings are more likely to get a divorce sooner. So, learning how to balance spending and saving money can improve your relationships.
How Do I Spend My Bonus Each Year?
If I got a $1,000 bonus, let’s look at three ways I could spend it…
First, let’s say I’m paying off a high interest loan from last year. I borrowed $1,000 at the start of the year with a 10% interest rate and now have to pay the $1,000 back plus $100 in interest. With this approach, the value I get out of it is about $900 (omitting inflation since it’s just one year).
|Bonus Spending Strategy||Value to Me|
|Spend Before Receiving||$900|
|Spend When Received||$1,000|
|Invest and Spend Dividends||$7,770 (explained below)|
The second approach is straightforward. I can spend the bonus when I receive it and the $1,000 is worth its face value. I don’t have to pay any interest or earn any interest.
Now the third approach is my favorite and how I personally spend most of my bonus income. I can buy a basket of healthy companies that pay close to an average of a 4% dividend yield. And hopefully I find even better opportunities when the market drops next.
I put my bonus income towards buying dividend achievers and aristocrats. These are companies that continue to pay bigger dividends each year, no matter what the market does. So, in the first year I’ll collect $40 and then assuming 6% dividend growth each year – the average S&P dividend growth rate – I’ll collect $42.40 the next year. Then in the third year, I’ll collect $44.94. The income compounds and in year 20 and 30, I’ll collect $121 and $217, respectively.
Each year my bonus will make me more money. It’s a steady stream of growing income and on top of that, the underlying $1,000 investment will grow. In the short-term (<5 years), the value will jump around. But I don’t plan on selling stock in the short-term thanks to my emergency fund and other savings. I can wait out a market crash and historically stocks have returned about 8%-10% over the long-run.
To get the big number in the table above, I’ve gone out 30 years. With that timeframe and assuming the lower 8% investment growth, the $1,000 will have turned into $10,063. Now, since that’s further out, inflation will have a bigger impact. So, I’ve discounted that amount with an annual 2% inflation rate to get $5,555. Then to get the total value of $7,770, I’ve added up and included the discounted dividend income each year for 30 years.
This is a simple model constrained to 30 years and it has some big assumptions. Although, it shows the power of saving and making your money work for you. And the sooner you start investing, the better!
In a Nutshell: When I get a $1,000 bonus, I see it as an extra $40 every single year that keeps growing. It’s an endless stream of income and if a financial hardship does come up – and my emergency fund doesn’t cover it -, I can tap into the $1,000 investment.
When possible, avoid taking from your future self (debt) or pay it off as soon as possible. Then the next step is to save money and invest. Interest can either work for or against you. Although, with that said, there’s an important balancing act between spending and saving.
Please don’t hoard every penny you earn. You work hard for your bonus income each year. So, it’s good to treat yourself and buy gifts for others… but do so in moderation and try taking a frugal approach. There’s a big difference between being frugal and cheap. To learn the important difference, check out my article that shares 30 frugal living tips to build a fortune.
Thanks for stopping by my blog. You now have more insight on how to spend your bonus wisely. A little delayed gratification goes a long way.
After reading this, do you plan on spending your bonus money differently? Or do you have any other comments or questions? If so, and if you choose to, please share your comments below.