Annual bonus time is a moment many of us look forward to with excitement and anticipation. Receiving a one-off injection of cash, in addition to your normal salary, opens up a world of options – some good, some bad.
It can be tempting to take a ‘punt’ on the latest hot investment ‘opportunity’ or to splurge on upgrading to a newer, more expensive car. However, poorly thought through, snap decisions such as these rarely have a positive long-term impact on your life and certainly not on your finances.
It is important to be mindful when deciding the best use of your bonus. Try to resist the temptation to simply spend it and instead, take the opportunity to make a positive step forward with your finances and wellbeing.
Following these simple steps will help ensure you get maximum benefit from your hard-earned bonus:
Step 1:
Spoil Yourself…a little
You have worked hard for your bonus so you deserve to enjoy some of it. Separate an amount to spend on whatever you want but try to limit that to around 25%.
Step 2:
Pay down Credit Card and/or Personal Loan debts
If you owe money on your credit cards or have a personal loan with your bank you should make repaying that debt your first priority.
This type of debt typically has very high interest rates (credit card interest is often over 20% per year) meaning that the debt can snowball extremely quickly.
Use your bonus to pay as much of this debt as possible and adjust your spending habits to make sure you don’t accumulate any additional debt in future.
Step 3:
Build a buffer
If you are free of consumer debt your next priority should be to build a savings buffer.
This ‘emergency fund’ should be equivalent to 3 – 6 months of your monthly expenses. The more people that are dependent on your income (e.g. young children) the greater the emergency fund you require.
The purpose of these savings is to cover unforeseen costs such as emergency house repairs, medical bills, periods of unemployment etc.
Failure to build an adequate savings buffer will leave you unprepared for unexpected costs when they arise. It will leave you with little alternative but to take out short term credit (see step 2) or take withdrawals from investments intended for the long term – both of these scenarios will seriously impact your financial (and maybe mental) health and should be avoided at all costs.
Your emergency fund should be held in cash deposits and be immediately accessible when you need it.
Step 4:
Invest in yourself
In the words of Warren Buffett “The best investment you can make, is an investment in yourself”.
Investing in your personal and professional growth can have a direct benefit on the quality of life you experience now and in the future.
An investment in professional development will present new opportunities to enhance your existing career or to follow a new path, whilst likely improving your earnings potential.
An investment in your health will improve your energy levels, and your physical and mental wellbeing, making you more prepared to excel in all areas of your life.
Step 5:
Invest for your future
Perhaps the most impactful step of all is to begin investing towards your financial future – a future in which you have the freedom to make the life choices YOU want.
Think of every investment contribution as taking you one step closer towards your financial freedom, where you can choose how you wish to live your life.
Place as much of your bonus as possible into your investment account or pension and repeat this step every year, throughout your career. As the years pass you will start to see this compound up in value and in turn, bring your financial independence date closer.
As the graph below shows, despite the various moments of concern along the way, a person who invested their bonus in the S&P 500 30 years ago would have seen it grow to a massive 21x its value:
Source: MFS How One Dollar Grew Over Time, March 2022 (Original Source: SPAR, Bureau of Labor Statistics)
Repeating the same investment annually throughout that period would have left that person in an excellent financial position today.
We can’t assume history will repeat itself exactly, but we can be pretty certain that investing in a globally diversified portfolio (ideally an index tracker or ETF to ensure that your costs of investment are kept to a minimum) will leave you in a hugely advantageous position in the future.
Step 6:
Repeat step 5 next year and every year after!
The path to financial independence is incredibly simple, if approached with cohesion and intent:
Regular, automated investment from monthly income
+
Mindful investment of your annual bonus
Repeated every year, throughout your career.
