What to do with a Bonus?
There are 3 ways to use a bonus (or any irregular lump sum of money like a tax refund, an inheritance from a relative, etc). You can use it to pay off past expenses, spend it now or save it for future expenses.
While there isn’t one standard best way to use bonus money, it is helpful to recognize how you typically approach bonuses and consider if that actually is the ideal strategy for you.
Paying for past expenses
When you know you have a bonus (or tax refund, inheritance, etc) coming your way soon, it’s common to pre-spend that money. It’s easy to justify or rationalize spending more than you can afford at the moment when there is a future bonus on the horizon.
You might decide to dip into your savings to buy the new couch you’ve been eyeing because you feel confident that when your bonus comes you can easily replenish your savings. Or you might feel comfortable taking on some credit card debt to pay for Christmas gifts, assuming your tax refund will come before too long, and then you’ll be able to pay off the card balance.
However, this cycle of pre-spending your bonus money can be risky. If your bonus, or tax refund, ends up being smaller than you expected (or doesn't end up happening at all), you are already committed to those purchases.
By pre-spending your money, you are taking away options from your future self. By the time you actually have the money, other, possibly more important, uses for that money may have popped up. By waiting until you have the bonus money in your account, you can make more informed decisions (based on what the total amount actually is and what your top priority is at that moment). You also avoid accruing any credit card interest fees by waiting until you have the money.
This cycle frequently coincides with overspending a bonus. The idea of an upcoming bonus can feel like permission to spend on several purchases. Unless you are paying close attention to the total dollar amount these new purchases add up to, you might find yourself feeling justified in spending way more than the dollar amount of your bonus.
Sure I can book that flight, I’m getting my bonus soon.
Of course, I deserve that new bag, I’m getting my bonus!
It’s time for a re-stock at Sephora, I can afford to do that now that I’m getting my bonus.
Brunch with the girls? My treat, I’m getting a bonus!
Our mental accounting skills are not great. It’s easy to rationalize that we can afford and deserve all of these seemingly small purchases, in light of an upcoming $1,000 bonus. But unless you pause to do the math (and don’t forget to factor in the taxes that are withheld on your bonus), you may overlook that your $500 flight + $350 bag + $100 at Sephora +$125 on brunch is $1,075. And your bonus, after taxes are withheld, is only $650.
Over-spending a bonus can cause you to be in a worse financial position, despite having just received this extra money. If the idea of a bonus unlocks a feeling of freedom to spend recklessly, you may want to create some bonus spending rules for yourself.
Spending now
If all your day-to-day necessities are covered by your regular paycheck, getting a nice little lump sum allows you to consider purchases that otherwise feel a bit out of reach. A bonus can be a great way to cover some of those irregular expenses that can be challenging to squeeze into your monthly budget.
With bonus money or found money, sometimes our brains treat it differently than money from our regular paycheck. Some people have a subconscious idea that bonus money should be used for indulgences, the more frivolous the better. While it’s not wrong to spend bonus money on indulgences or luxuries, it’s helpful to consider the values that guide your regular spending. Once the initial dopamine hit fades after the purchase, will this still feel like a worthwhile expense?
Having a running list (I keep mine in my Notes app) of necessary, desired, or even aspirational purchases, helps ensure that when bonus money comes in, you aren’t overly influenced by impulsive desires.
With a list of expenses that you have had in mind for months, it's easier to evaluate which, if any, of these expenses will meaningfully impact your quality of life or happiness. Likely, you’ll find that a few months in, some of the expenses that you put on the list aren’t that important anymore, and you’ll be glad you didn’t pre-spend a bonus on those things.
Don’t feel rushed to make a decision right away. It’s ok to let the money sit in your account for a few weeks, or even a few months. This gives you time to ensure you are making a good decision.
Future Spending (aka Saving)
The last way to use your bonus is to not spend it, at least not right now. For some people, the idea of saving money is a bit painful. It feels like if you don’t use it now, if you don’t spend it, it's essentially the same as losing it. Putting money in a savings account, or an investment account like an IRA or 401k, can almost feel like giving the money away. However, what you are really doing is gifting your future self the opportunity to spend that money.
When you don’t immediately spend your bonus, you can use it to build towards bigger (and often more exciting) future goals. Perhaps you can set it aside to pay for next summer’s vacation.
While setting your bonus money aside for a future goal doesn’t have the same dopamine hit as going on a payday shopping spree, the joy and satisfaction of taking a vacation that is paid for in full is significant. And for bigger goals, ones that may feel impossible to squeeze into your monthly budget, like building an Emergency Fund or saving for a down payment, a bonus is a great chance to make significant progress or to speed up the timeline on reaching those goals.
Making your future goals more specific can help make saving feel more enjoyable and motivating. Instead of just leaving the extra money in your checking account, transfer it to a separate savings account that you’ve named “Margaritas in Mexico” or “Dream Kitchen Renovation”.
The idea of “saving” $2,500 may not have the same dopamine hit as spending it. But if you have very clear goals, and can vividly picture how you will feel future-spending that money (sitting on the beach, cocktail in hand, or sitting in the driver seat of the new car you are working towards), you may be able to still experience some of that dopamine.
Creating a Bonus Framework
You don’t need to take an all-or-nothing approach with your bonus. You may be able to pay off some recent expenses, spend little now, and still have some left to save for future goals.
If you create guidelines for yourself going forward, it will be easier to avoid the temptation to use it all on a big splurge. By developing a framework for yourself, you can alleviate some of that in-the-moment decision-making.
You might, for example, decide that when you get bonuses you will put 50% of it towards future-oriented goals, 40% towards a purchase now (a new mattress, the boots you’ve been coveting, etc), and 10% to splurge on more frivolous/impulse purchases.
You will likely come up with a different percentage breakdown, based on your current situation and goals. But with a framework like this, the decision is less about whether should I spend or save the money. Instead, it becomes:
Which goal will I focus on for the 50% savings?
Which thing on my “to buy” list is the top priority for me right now?”
What’s the most fun I can have with the remaining 10%?
Creating your own framework will make it easier for you to make good decisions for yourself.
Using a bonus to pay off debt
Receiving a bonus is a great opportunity to pay down debt at a faster rate. If you are using your bonus to pay down a mortgage, car loan or student loan, that is essentially the same as saving for a future goal. You are effectively using that money to reduce the amount of future loan payments. You are shortening the timeline until that loan is paid off, or you're reducing the amount you will owe in future months. You are positively improving your overall net worth.
However, if you have recently accumulated credit card debt, and are using your bonus to pay down that balance, it’s more like pre-spending.
If you are frequently spending more on your credit card than you can afford to pay off each month, your bonus likely isn’t moving you financially forward, it's being used to help you tread water.
If your bonus is already spoken for (paying off recent purchases), it’s challenging to shift towards a more forward-thinking approach with your money. By paying closer attention to your monthly spending, and trying to anticipate some of those irregular but inevitable expenses, you’ll be less likely to depend on future bonuses just to stay afloat.
If you’ve been feeling financially stuck, a bonus can be a great catalyst for improving your financial situation. However, if you are struggling to get out of that pre-spend cycle, that might be a sign that you’d benefit from some support in managing your money. Schedule a free call with Sarah to learn more about 1:1 financial coaching.
