An increment or a bonus is undoubtedly a mood booster. Whether it leads to employees improving their performance is another matter. However, if handled well, extra money can definitely boost one’s personal finances.
Even before sharing some thoughts on how to handle additional money in the form of increments and bonuses, here is something that’s a little delightful: No one needs to be that person who tries to save it all!
Yes! You heard it right! It’s perfectly fine to spend some of the extra money. Don’t try to spend it all, though. But if it means taking that long-awaited holiday or buying that coveted expensive device after waiting for years, then go ahead and use some of the extra money to tick off these desires.
With that out of the way, here’s what should be done next:
Pay off high-interest debt
Use the bonus to clear any large and unpaid credit card or personal loans, if any. If that doesn’t help much, then use some money from the salary increment to increase the prepayment. Credit cards charge almost 40 percent interest and personal loans can cost about 15 percent. Both are weapons of financial destruction and should be cleared quickly.
Start/build an emergency fund
For those without a financial cushion in the form of an emergency fund (the suggested size is at least six months’ worth of expenses), then try setting one up with this bonus money. For existing contingency funds that may need to be enhanced due to increased responsibilities, the amount can be increased gradually.
Fill gaps in insurance portfolio
For those who are underinsured and without any large term plan coverage, it’s time to buy it. If health insurance is inadequate, then once again, use the additional funds to buy adequately large health insurance coverage. Do not avoid or delay these two decisions.
Prepaying home loans
Those without credit card or personal loan dues but with a home loan may consider increasing the prepayments. However, because it’s a low-cost loan with tax benefits, some feel that it’s not worth aggressively repaying home loans. Instead, one should allow them to run their regular course.
But there are those who don’t like liabilities and want to clear all loans quickly, then the bonus and salary hike can be considered for this. A part of the bonus can be used to make lump sum prepayments and a part of the monthly salary hike can go towards increasing the monthly instalment.
As an example, assume a Rs 75 lakh home loan taken at 7.5 percent interest for 25 years with an EMI of Rs 55,424. The borrower decides to use Rs 1 lakh from the bonus every year to make a lump sum prepayment and also to pay an extra Rs 5,000 every month. Result? The duration of the home loan shrinks to 15 years and instead of Rs 92 lakh, about Rs 51 lakh is paid as interest.
Bump up on-going investments
If, after taking all these steps, there is still money left, then thank the bosses first! And then, increase investments to achieve financial goals faster. How? I wrote about it in detail here why SIPs must keep pace with your salary hikes.
Consider this example: A Rs 25,000 monthly SIP over 20 years and assuming 10 percent returns will result in a final sum of about Rs 1.89 crore. But using annual increments to increase the SIP by 10 percent will instead accumulate Rs 4 crore. This is why I recommend that SIPs should be increased periodically for all goal-based investments.
I’m sure there are several other ways to utilise increments and bonuses. But this listing is meant to provoke people to think. What works for one person may be very different from what works for someone else. It may even be suitable for someone to combine a few of the strategies discussed.
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