Photo Credit: Edith OSB via Compfight cc
I haven’t blogged much about finances in quite some time. Mostly because we’ve been in a financial holding pattern, but also because life has been so full of kids, pregnancy and other daily life stuff that sometimes money seems so mundane to write about. But recently I’ve been thinking a lot about how and why we manage our money the way we do. Those are our money values. Those same values apply when unexpected and or unplanned for money comes our way.
Windfalls are pretty much the result of luck, by definition. While things like rebates, bonuses and tax returns can be counted on to a certain extent, they are not guaranteed. The questions always becomes, what to do with the money? Many people view this as essentially free money, and therefore can be used for fun activities. I don’t entirely disagree with this. For most of the last six years, we haven’t had a regular line item in our budget for fun or eating out. This can be a tough way to live and can result in what I call “Frugality Fatigue”. My definition of frugality fatigue is when you have been living very leanly for a long time. (You can read more about that here). Your definition of leanly and long will probably vary. Using small windfalls for those little luxuries can be a good way to prevent long term bitterness or frustration that can lead to larger poor choices. Yes, it is always wisest to save or pay down debt with any extra money. But using a small amount of unexpected money for little treats can help us stay on the long term path to healthy financial living.
Bigger windfalls require more careful consideration. Just because you tax return is $1,000 larger than expected doesn’t mean that it’s free money to be spent however you like. (A tax return in particular is a refund of YOUR hard earned money that the government has been holding onto for the last year. This is not free money, but rather your money being returned to you. Spend it accordingly).
If you don’t have an emergency fund to speak of, that’s a good place to start. I find that a good minimum emergency fund is at least one paycheck, one month’s income is better. A lot of articles recommend six months to a year of income in your emergency fund. But if you have no savings or a lot of debt, that feels like an impossible mountain. The financial guru Dave Ramsey recommend starting with $1,000 emergency fund and then proceed with paying off debt. If that’s all you can manage in the beginning, start with that.
You (and your spouse if you are married) need to decide together what constitutes a windfall (is irregular income a windfall or income? Etc.) and what constitutes a large windfall vs. a smaller one. In our household I handle the majority of the money, and for the small amounts (less than $50 typically) I usually decide what’s going to happen to it. Examples of this includes credit card rebates, or small survey payments like those I get from Pinecone Research (I typically cash out around $15). I usually funnel these into our date or fun fund, for doing things like getting pizza or ice cream with the kids or saving towards a dinner out for us.
In my opinion the best choices for a large windfall or as follows:
Build an Emergency Fund
This is for actual emergencies. (Job loss, illness, unexpected car or house repairs not covered by insurance). Not for sudden invitations to nights on the town or vacation opportunities. Those are fun things, but should be saved for in another way. An emergency fund is designed to keep you from having to max out your credit card or take out some other kind of loan when faced with unforeseen expenses that you don’t currently have the cash for. Decide how big an emergency fund you need to have to start with and make that your goal.
Pay off debt
Pay off debt, especially high interest debt. Since the current rates on savings accounts are so low, I recommend paying off debt over putting money in savings, once you have formed a small emergency fund (designed to help prevent you from unnecessarily going into debt again).
Start creating a larger savings account beyond your emergency fund.
If your emergency fund is at a level you are comfortable with, than start a larger savings account for small short term dreams and upcoming expenses. Car or large appliance replacement, a weekend away, a family vacation, an upcoming wedding, or big things like home purchase or renovation.
Sometimes this may have to be done at the same time as paying off debt, especially large debt that will take a long time.
Invest for Retirement and the Future
Personally, I’d choose a Roth IRA (post tax) or traditional IRA (pretax) over a 529 plan (college savings) for this reason; you can borrow for your child’s schooling if you must, (or let them take out loans and help them pay them off later) but you can’t borrow for your retirement. This doesn’t mean you shouldn’t do both, but many parents focus so much on trying to save for their children’s education that they don’t think about their own futures until it’s too late.
Some people would argue that Investment should always come first. I am not a financial planner, so it’s possible that I am totally wrong about this. But I am also of the generation who saw the “Great Recession’ and watched a lot of people lose years of their retirement savings, basically starting over from scratch when the dust settled. It also doesn’t make logical sense to me to invest in something that is a gamble when you still have debt. Paying off debt is a guaranteed return!
Obviously these are just some ideas. But when a large sum of money comes your way, it’s best to have a plan for it, even if those plans include wants or dreams rather than practical choices. That way you’ve made intentional choices with your money. This puts you in the driver’s seat of your financial future.