August 2007
Barbara O’Neill, Ph.D., CFP®
Extension Specialist in Financial Resource Management
Rutgers NJAES Cooperative Extension
From time to time, you may receive a financial windfall. Perhaps it is an income tax refund or, in some states (e.g., New Jersey), a property tax rebate. Other common windfalls are retroactive pay or a year-end bonus at work for a job well done. Or you may receive a cash gift, inheritance, award, or prize.
While the temptation to spend windfalls is often great, this money can be a wonderful way to jumpstart your future financial security. For example, instead of saving $20 a week for 50 weeks to accumulate $1,000, a windfall would provide this money all at once. Therefore, windfalls can be thought of as “small steps to wealth on steroids” because they provide a significant “chunk of change” all at once.
Below are five ways to use your windfall wisely:
First, pay off high interest credit cards. These are the greatest threat to your financial well-being. If you are like the average consumer, you probably have a number of creditors. Pick the debt with the highest interest rate, or choose any credit card that charges interest based on a two-cycle average daily balance, and use your windfall to pay it off or at least make a big dent in what you owe.
Second, create an emergency fund. Many households don’t have one. According to the U.S. Department of Commerce, the U.S. savings rate is at its lowest level since the Great Depression. There are several theories on how much you need in an emergency account. If your job is one where you might expect layoffs or downsizing, then you need to have more set aside. Think about how long it will take you to find a new job. How long could you survive financially on your current savings? Having from 3 to 6 months’ living expenses in savings is a good idea and your windfall will get you there faster.
Third, save for retirement. Assume that you receive a $2,000 windfall annually from one or more sources. That $2,000 per year can be your ticket to financial security, especially if you start saving early. For example, if you’re 25 and you earn an average 10% return, the $80,000 (40 years x $2,000) that you save will turn into a million dollars for your retirement. Place your windfall in a tax-deferred Roth or traditional IRA to maximize its growth. Another strategy is to use the windfall to create a “paycheck” back to yourself (i.e., regular withdrawals) to offset increased payroll deductions to an employer 401(k) or 403(b) plan.
Fourth, invest your windfall in yourself. Taking a college course or other skill-enhancing program (e.g., computer training) could increase your earning capacity for years to come. Economists call this your “human capital.” Think of this use of your windfall as “the gift that keeps on giving” because education is something that is always a part of you. The more education and training you have, the more attractive you are as an employee in your current job or a new one.
Finally, consider opening a mutual fund account with your windfall. Once you make the initial required deposit with windfall funds, subsequent deposits will probably require much less. For example, a mutual fund might require $1,000 to open an account but only $50 or $100 for subsequent deposits. For further information about investing, visit the Rutgers Cooperative Extension Investing For Your Future Web site at www.investing.rutgers.edu and personal finance website at www.njaes.rutgers.edu/money.