Congratulations! You just came into a significant sum of unexpected money! Now what?
When you receive a financial windfall whether it comes in the form of a tax refund, bonus, inheritance, or some other unexpected lump sum, chances are you have already imagined what you might do with that kind of money. You may be thinking about vacations, paying off debt, or increasing your standard of living. But what is the wise thing to do?
If you have been blessed with an unbudgeted bit of money, ultimately you should use it to decrease the financial risk factors in your life. Sure, going on that beach vacation you have always wanted to take your family on would be a dream, but it could feel more like a nightmare if you spend all you had on it and then fell into some unexpected expenses when you got home.
First things first, we like to tithe on any income, including windfalls. You should give according to your own religious tradition and convictions. After that, if you have any debts at all, you should use the windfall to begin paying them off. Other than your mortgage, the first place a windfall should be spent is paying off consumer debt. Debt is inherently risky. Once the debt is paid off, think about it this way: Your windfall could offset hundreds or thousands of dollars of debt payments every month that can now be allocated to something else. For example, the average American spends a whopping 24% of their take home pay each month on consumer debt payments. If you used your windfall to pay off all your consumer debt, that 24% increase in disposable income each month would feel like a huge raise!
The next thing to do, is put money aside in cash savings in the event of an emergency. I recommend around 3-6 months of your living expenses be set aside in cash. You might need to aim for the high-side if you have aging cars, appliances, etc. Think of it as a Rainy Day Fund. This can be used if there is a job loss, major medical expense, or major house or vehicle expense. I know dumping money into a savings account doesn’t usually constitute “fun” but trust me when I tell you, you will be glad you did. We recently had a stretch of expensive mechanical incidents, mainly car brakes and house air conditioning unit, that were in part subsidized with old unspent windfall money. As I’m writing this, hurricane Harvey is pummeling Houston, and I can only imagine all the unexpected expenses that so many Texans will be confronting, much of which may not be covered by insurance. Hopefully, you won’t have to use it, but the availability of those rainy day funds bring a lot of security into your financial situation when bad things happen.
If there is money leftover after paying off your debts and topping off your savings, then things can get a little fun! I think a vacation or luxurious purchase at this point is completely acceptable. We like to quote the scripture: “don’t muzzle the ox while it treads!” 1 Timothy 5:18. We also think it is fun to be able to give money to a favorite charity, a kid preparing for a mission trip, or something else along those lines. However, if you know you have other financial goals that could use a boost (think college or retirement savings) keep the frivolous spending low so you can invest wisely in those areas next.
Obviously, the amounts of windfalls vary dramatically. This post is intended to give you a place to start utilizing that money in the wisest ways possible. Give, pay off debt, then save, then spend it on something fun! Use this windfall as an opportunity to begin or continue healthy financial habits. Remember the guiding rule here is decrease your risk, increase your savings, have fun!