Did your employer shower you with a nice holiday bonus this year? Lucky you! While it might be tempting to run out and spend like crazy, we Fools think that bonus money is best used to put yourself on firm financial footing.
We reached out to our team of Motley Fool contributors and asked them for their best suggestions on how to use holiday bonus money. Read below to see what they said.
One way many people use holiday bonuses is to set them aside for major expenses down the road. If you have children, it's easy to put off saving for a college education, yet you have a specific time frame during which you can save and invest before your kids graduate from high school. Opening a 529 plan account is a great way to get your educational savings started on the right foot.
A 529 plan lets you invest money on a tax-deferred basis and avoid tax on income and gains as the funds accumulate and your kids approach high-school graduation. Moreover, distributions from a 529 plan are free from federal income tax so long as you use the proceeds for qualified educational expenses. 529 plan assets are generally treated as being owned by the parent rather than the student, and that can have favorable financial-aid impacts as well.
You have to be careful to avoid high-fee plans, but a wide range of choices around the country give you plenty of affordable options that will let you maximize how far your college savings will go over the long run.
Congratulations on your holiday bonus! Now, if you want to do something really smart with that money, consider opening or adding to the emergency fund you've been neglecting.
I know the idea of saving for a rainy day may not sound like fun, especially when your boss just bestowed you with free money. However, unexpected expenses are one of the leading causes of bankruptcy. A large home-repair bill, an unexpected illness that requires hospitalization, or the loss of a job are all risks you need to save money for. You never know what life might throw your way.
What's the right amount to save up? That all depends on your monthly spending habits, which in turn means you should be working with a monthly budget to understand your income and cash outflows. When formulating your monthly needs, you should take into consideration the basics, such as housing, food, and utility costs, as well as personal expenses, debts, and potential healthcare costs. A good target is to save up enough money to cover up to six months of these basic expenses.
Additionally, the key here is not simply to throw this money under your mattress, but to keep it in an interest-bearing, easily accessible account. With the Federal Reserve expected to gradually raise lending rates in the coming years, perhaps now is the time to consider putting your emergency fund in an interest-bearing savings account. Also be sure to shop around for a competitive interest rate.
If you're saddled with any high-interest-rate debt (such as that from credit card accounts), then one of the best uses of any excess funds is to pay that debt down -- or to pay it all off if you can. It's even worth taking extreme measures to do so, such as getting a side job for a while. That's because carrying high-interest rate debt is essentially the opposite of investing for growth. (Low-interest-rate debt, such as a mortgage, is far less problematic.)
If you owe, say, $20,000, as plenty of people do, and you're being charged an annual interest rate of 20%, as plenty of lenders charge, then you're in danger of being sucked into a black hole. You'll be on the hook for about $4,000 in interest for just a single year, for starters. If you pay only that interest, you still won't have reduced your balance by much, so you'll owe a similarly high amount next year. Many thousands of dollars are going up in smoke, whereas if you were debt-free, they could have instead been growing in retirement accounts. If you can't manage to pay all the interest you owe, your balance will rise. The bigger it gets, the more you'll owe. See how hard things are getting?
It's critical for most of us to have an emergency fund and retirement accounts, and many of us would like some money to enjoy each year, too, for things like vacations. But it's extremely hard to get ahead when you're being pulled in the other direction by debt. If you're fortunate enough to receive a few hundred or a few thousand dollars as a holiday bonus this year, then consider applying it all to your debt.
Once your debt is gone and you've fully funded an emergency fund, using any extra cash to pump up your retirement savings can be a great long-term move, and if you qualify to contribute to them, then funding a Roth IRA is likely the best way to go. Roth IRAs hold numerous advantageous over other retirement accounts that make them an ideal place to keep any bonus money.
The biggest benefit Roth IRAs offer is that they provide tax-free compounding, meaning you never have to pay taxes on any capital gains or dividends your investments produce. That one benefit alone makes them a slam-dunk choice, but there are other benefits to funding a Roth IRA as well.
One major advantage is that money contributed to a Roth IRA isn't tied up the same way it is with other retirement plans, such as 401(k)s or traditional IRAs. Roth IRAs allow you to withdraw any contributions -- but not any investment gains -- that were made over the years at any time, for any reason, penalty-free. This allows Roth IRA contributions to act as an extra emergency fund, which could come in handy one day down the road if you ever experience economic hardship.
If you're a homeowner, one way you could put your holiday bonus to work is by investing it in solar panels for your home. Depending on where you live, and how much power your family consumes, you can really save a lot of money over time by making the switch.
According to a number of sources, solar panels can produce electricity for 20%-30% less than the average utility company costs, and that can be worth thousands of dollars per year for the average home. Solar panels can be expensive, with prices for a solar electricity system ranging from below $10,000 to more than $20,000 depending on where you live and how much power you need to generate, but they also last a long time. Most solar panels are covered by warranties lasting up to 20 years, and they can remain effective for up to 30 years in many cases.
Not only could putting your bonus toward a down payment on solar panels save you a lot of money in energy costs over the next couple of decades, but it's also a smart move for the environment, cutting down on emissions and particulates produced by coal and natural gas-powered electrical plants.