What To Do With Cash: Pay Off Debt Or Invest?
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Sometimes we find ourselves with a little extra cash through a tax refund, a bonus at work, or some other unexpected windfall. What are you going to do with all of that money burning a hole in your pocket? Treating yourself is sometimes nice, but there are often smarter ideas for money management. Those who want to put that money to work should start by answering three important questions.
1. Do you have any liquid savings?
Nobody likes to plan for things to go wrong, but most of life’s emergencies can be taken care of with less than $1,000. Do you have at least this much on hand right now? If not, use some of your newly found cash to establish an emergency savings account. The $1,000 needs to be in a liquid vehicle like an FDIC savings or money market account because it isn’t a matter of if something will happen, it’s a matter of when. If you ever need to use this liquid savings, your goal should be to replenish it as soon as possible.
If you have addressed your emergency account and still have cash left over, consider the next question.
2. Do you have any debt?
You will build your wealth more quickly when you are earning interest on your money instead of paying it to someone else. Use your extra cash to pay down unsecured debt and debt on depreciating assets, such as vehicles you own.
I like to remind people that what the credit card company or bank charges you is guaranteed. If your credit card is charging you 16 percent, by paying it off, you are essentially earning an immediate 16 percent on your money.
While we are talking about credit cards, here is a bit of advice: Ideally you will only charge what you can pay off in full each month. But if you carry a balance, you should limit this to 30 percent of the total amount you can charge. For example, if your credit limit is $1,000, you shouldn’t have more than $300 carried over to the following month. I am not telling you to spread your balances around several cards but instead to limit your use of credit—and use it wisely.
3. Can you afford to lose this money?
You made be tempted to roll the dice for a higher rate of return by investing any leftover funds, but a good rule of thumb is to never invest money that you are not willing to lose. I don’t care whether you’re investing in a house, commercial property, stocks, bonds, precious metals, or any anything else. You can lose your money. If you decide that you still want to invest, consider meeting with a Certified Financial Planner™ to help you identify and reach your financial goals and objectives. CFPs are trained to explain the risk and cost associated with investing.
These three questions can help you decide how to allocate your resources anytime—not just when you have extra cash. It’s not always a bad thing to spend your money, but by paying off debt and saving or investing when you can, you’ll be better prepared for the future.
Steve Repak, CFP®, is a professional speaker and the author of Dollars & Uncommon Sense: Basic Training for Your Money.
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