Investing Strategies: You Got That Bonus. What Are You Going to Do with It?

You work hard and are compensated accordingly. You might even be entitled to a bonus when you contribute to the well-being of your company. What you do with that bonus money can potentially make a big difference in how you meet your financial goals—as well as the lifestyle you enjoy in retirement.  

“Many highly compensated individuals receive good-sized bonuses once a year or even quarterly,” said Robert Siuty, senior financial consultant at TD Ameritrade. “The key is to know how to use those bonuses in a way that might help you move forward with your life and your money.”

Consider Your Lifestyle

The first step, according to Siuty, is not to decide what to do with bonus money. Instead, it’s to look at your lifestyle and make sure you’re bringing it in line with your regular salary.

“It can be tempting, especially if you have a quarterly bonus, to plan your expenses with your bonus in mind,” said Siuty. “Instead, in an ideal situation, you'd maintain everything on your regular and expected household income.”

Consider taking steps to evaluate your current financial situation and figure out how you can bring your regular expenses within your steady salary. That way, Siuty pointed out, you can use bonuses as a way to work toward better financial outcomes.

“These bonuses are larger in nature, so it makes sense to save a lump sum,” said Siuty. “Adding to a diverse portfolio with bonus dollars can potentially help speed along the accumulation, so if you have an annual or quarterly bonus, try to save as much as possible.” 

Use a Bucket Strategy

When deciding what to do with bonus money, Siuty suggested using a bucket strategy to help maximize its effectiveness. “Earmark your bonus for different goals, depending on what you’re trying to accomplish and how soon you need the money.” 

Think about the multiple goals you’re pursuing with your money. Some common goals include:

• Retirement
• College fund for the kids
• Saving up for a second home
• Setting money aside for children’s weddings
• Investing in a business

“It’s always a good idea to be saving for retirement anyway by setting aside a portion of your paycheck,” said Siuty. “However, putting a portion of your bonus toward retirement might be able to help you if you have a goal to retire early or if you want a higher quality of life during retirement.”

He also pointed out that many people have goals to help their children pay for college or to buy additional properties. Reaching these goals might be easier if you allocate bonus dollars according to current priorities and when you need the money.

“Sit down and crunch the numbers to decide what percentage of your bonus could be allocated to different goals,” said Siuty. “You might put more toward buying a second home if you want to buy in the near future or put a bigger percentage toward your children’s college savings if they’re approaching high school graduation.”

As you reach different goals, shift the allocation of the bonus into different buckets as needed. The key, though, is to identify your financial objectives and use a bonus to help grow your wealth in a way that helps you meet your goals faster or more effectively.

A Plan for Your Bonus Is Key

It’s important to have a plan for bonus money; otherwise you could end up spending it on something that isn’t as important to you. While there’s nothing wrong with buying a car or boat as a treat when you get a bonus, such instant gratification can potentially cost you in the future, according to Siuty.

He used buying a $40,000 car as an example, pointing out that the car is a depreciating asset that won’t be worth nearly what was paid in 10 years. On the other hand, an investment of $40,000 at a 7% annualized rate of return could almost double in that time, based on the Rule of 72.

“While you can’t rely on a perfectly consistent rate of return from the markets, the reality is that you’re likely to have more money later when you invest,” said Siuty. “In 10 years, that $40,000 might be worth close to $80,000, and in another 10 years, that $80,000 could almost double to close to $160,000.”

A plan can help give you a clear place to put the money and potentially help you to improve your financial future, rather than spending the money without really thinking about its potential impact.

“If you want that car or that boat, there’s nothing wrong with buying it with part of a bonus, or creating a savings plan to buy it after you’ve received two or three bonuses,” said Siuty. “Just make sure you know how it fits into the rest of your plan and that it isn’t detracting from other things you want to accomplish with your money.”

Bottom Line

“At the end of the day, there’s no right or wrong answer when it comes to what to do with your bonus,” said Siuty. “Instead, it’s about what you want for yourself financially.”

Putting the money in a properly diversified portfolio or different accounts designed to help you pursue your goals can help you take advantage of compounding returns and help you parlay your bonus into better outcomes for your finances.

“With a good lump-sum bonus, you can start to snowball that money into a bigger pool of assets that can potentially grow faster,” said Siuty. “This can put you in a sweet situation to pursue your goals and even possibly retire earlier and live a nice lifestyle later.”