Sometimes in life, you get lucky by getting an unexpected bonus at work, an incredibly generous birthday gift, an inheritance, or some other sort of monetary windfall. What should you do with it? Let’s be honest: If you put that $1,000 into your checking account without any plan, you’ll probably end up frittering it away with nothing real to show for it. You could blow it all at once on one epic night out or some fancy new clothes. The thing is, though, after you spend the money on luxuries, you’ll be in the exact same financial position you were before. Instead, you should put the money toward your financial goals.
Boost Your Emergency Fund
Why do you need an emergency fund? Because life happens. Inevitably, your car will need new brakes, the cat will get sick, your hot water heater will stop working, someone will end up in the emergency room, or a paycheck won’t arrive on time. An emergency fund can help you weather tough times without adding to your debt load. Your emergency fund might also come into play if you are new to budgeting and forget to budget for absolute must-haves, if you lose your job, or if you live far away from your family and need to travel unexpectedly. The conventional wisdom is that you should have enough to cover three to six months of expenses saved in your emergency fund, which can sound completely overwhelming. But having $1,000 put aside will give you enough of a cushion to handle most smaller emergencies.
Create a Checking Account Buffer
Are you living paycheck to paycheck, or are you regularly getting hit with overdraft fees in your checking account because you are trying to time when payments will clear? You need a buffer. The buffer sometimes goes by other names, like a mini-emergency fund, a rainy day fund, or a cushion. The strategy goes like this: Deposit that $1,000 into your checking account, then pretend that it isn’t there. Whenever you check your balance, mentally deduct $1,000 (so you don’t spend it on a coffee run). However, let’s say your electric bill is due Wednesday and your paycheck automatically deposits on Thursday. Your buffer will let you pay your electric bill on time, and then your paycheck will refill the buffer (because you budgeted for the electric bill to come out of your paycheck, not the buffer).
Pay Down Debt
Getting out of debt is a common financial goal, and a windfall is a fantastic way to make a big dent in your debt. Before you send your windfall off, however, decide how you want to make the most significant dent in your debt load. Some people pay off their smallest debts first because they then have fewer minimum payments and can use this freed-up money toward the next-smallest debt. Paying down debt in this way is called the snowball method. It’s very satisfying to knock out a debt! The other method to consider is to pay down the debt with the highest interest rate, which will save money over the long term, since that’s your most expensive debt. Paying down debt in this manner is called the avalanche method. Pick the debt payment method that makes the most sense for you!
Pad Your Retirement Savings
The conventional wisdom is that the earlier you start saving for retirement, the better off you will be. If your employer offers a 401(k) or 403(b) retirement plan, take advantage of it. And if your company matches your retirement savings, make sure you’re investing enough to get the total matching amount. If that’s a struggle, use your windfall to replace the money deducted from your paycheck. Since your retirement contribution is taken out pre-tax, the hit on your paycheck might be less than you would expect. If you are already maxing out your employer-sponsored retirement savings or if your employer doesn’t offer one, open an IRA. Most IRAs are funded with post-tax dollars, which also makes it easier to access the money if you need it before you reach retirement age. You can transfer your windfall straight into your IRA. But keep in mind that there are contribution limits for both IRAs and 401(k)s.
Increase Your Sinking Funds
In personal finance circles, a sinking fund is a way of earmarking money for special expenses. Think of it as planning for emergencies you know are going to happen or non-monthly bills you know you will have to pay. If you have a pet, you know you’re going to end up at the vet at some point. If you own a car, eventually, something will need to be repaired. If you own a house, something will inevitably need to be renovated. Sinking funds are also a great way to plan for semi-annual or annual expenses like car insurance or property taxes. Saving toward them a bit at a time keeps you from scrambling when the inevitable happens or a bill comes due. Use your windfall to plump up your most critical sinking funds.
Earmark it for a Special Purchase
Making a special purchase with your windfall can be a great use for it, as long as your emergency fund, debt load, and retirement savings are all on track. Maybe your best friend is getting married and you can use the money to attend their wedding. Or perhaps something is falling apart: Your car radio doesn’t work, your sofa is in tatters, or your cell phone won’t even update anymore. Your daily budget may not extend to replacing them, but your windfall could let you buy something that will improve your everyday life immensely. That’s a great use of money.
Invest in Your Legal Future
One of the responsibilities of being an adult is planning for what happens if you can no longer make decisions for yourself or what will happen after you die. Deciding on who should have power of attorney to make decisions when you can’t, choosing what medical interventions you want, and determining how to split up your assets or who gets custody of your children (or pets!) are vitally important decisions. You want to make sure your wishes are clear and legally enforceable. Having an attorney oversee your power of attorney, advance directive, and will can ensure that the paperwork is completed correctly. Hiring an attorney costs money, of course, and the expense might be outside of your regular budget. Using your windfall to pay an attorney to draw up these plans would be a great use of the funds.
Invest in Yourself
Don’t forget to invest in yourself. Is there a particular class, skill, or certification you could get that would allow you to change careers or make more money on your current career path? Using your windfall to improve your future earning potential is a great idea. If you’re considering going back to college or attending graduate school, the money can help you afford application fees (which add up fast!) or necessary entrance exams. Using your windfall to improve your earning potential will allow the money to come back to you in the long run.