People always say that money doesn’t just fall out of the sky. But every once in a while – whether it’s a bonus from work, an inheritance, or even lotto winnings – it does!
Receiving an unplanned sum of money like this is referred to as a windfall. Although there is no set amount to define a windfall, you’ll know one when it lands in your hands.
The problem with windfalls is that if you don’t do something productive with them, there’s a good chance they’ll slip between your fingers. For instance, take lotto winners. According to the National Endowment for Financial Education (NEFE), 70 percent of recipients lose all the money they received within several years.
This is why many financial professionals often suggest using a windfall to do something positive for your finances – namely paying off unwanted debts like credit cards, student loans, or even your mortgage. However, is this really the best option for your windfall, or could there be even better uses? In this post, we’ll discuss when paying down debt makes sense and explore some other possibilities.
When Should You Pay Off Your Debt?
Paying off your outstanding debts is generally a good thing. If nothing else, you’ll be releasing yourself from the financial and (let’s not forget) legal obligation of paying someone back for the money you borrowed.
Here are a few of the most common instances when it makes good sense to eliminate your debt – especially if you’ve recently come into a large windfall.
High Interest is Crushing You
Not all debt is created the same – especially when it comes to the APR or annual percentage rate (i.e. interest you owe) of the money that’s been borrowed. If that number is too high, then you may be hemorrhaging money without even realizing it.
A good example of this situation is a revolving credit card balance. Because credit card interest compounds daily, it doesn’t take very long for your balance to double in size – you can see this for yourself using a free online calculator. In this case, it would make sense to pay off the balance immediately.
Free Up Cash Flow
Another thing debt can do is get in the way of how much money you have available to spend. A few hundred dollars here or there for your vehicle or a personal loan can easily take a bite of a thousand dollars or more out of your monthly budget.
This is precisely the reason that many financial professionals will recommend that people who are about to enter retirement should pay off their homes first before separating from employment. By eliminating what is probably their biggest monthly payment, the mortgage, their retirement income will stretch a lot further.
Mental Relief
There is something very satisfying about becoming debt-free. Especially if you’ve ever felt anxiety or panic over waiting for your next paycheck or how you’ll make ends meet, the act of eliminating what you owe others can be an undeniable feeling of accomplishment and positivity. If putting your mind at ease is something you prioritize above all other financial goals, then pay off what you owe until you’re at a level where you feel comfortable.
What Else Should You Use Your Windfall to Do?
Paying off debt certainly has a lot of great benefits, but it may not always be the most sensible financial move. There may be other places where your money could be better utilized. The following are a few examples.
Contribute More to Your Retirement Accounts
If you’re not already maxing out each of your retirement accounts such as your Roth IRA or 401(k), then you could use your new-found windfall to assist. Not only would saving more help increase the potential growth of your nest egg, but you’d also be taking advantage of sheltering your contributions as well as future earnings.
Though you wouldn’t be able to make a direct contribution to an employer plan, you could use the extra funds to offset your income and increase your contribution limits for the year. For example, if your windfall is $10,000, then you could raise your 401(k) contribution by the equivalent amount and then spend the $10,000 windfall on your basic living expenses.
Buy Income Producing Assets
Ever thought about becoming a landlord? What about owning stocks, ETFs, or REITs that pay monthly distributions? There are plenty of investments that you could purchase and will produce additional income streams.
A good rule of thumb is to compare the interest you owe on your debt versus what you may potentially receive. For example, if you were lucky enough to have gotten a mortgage a few years ago when interest rates were around 3%, then it makes more sense to keep your windfall in a CD where the distributions are closer to 5%.
Improve Your Home
For most Americans, their home is their greatest asset. However, if you have important maintenance or major upgrades that are left undone (such as a new roof or outdated appliances), then this could impact the marketability of your house someday when you go to sell it. Therefore, you could pump some or all of the windfall into home improvements that will have a good ROI.
Finance Your Education
It’s often said that the best investment a person can make is in themselves. If you’ve always wanted to finish college or get a specific certification, now could be the time to do so with these new funds. Carefully consider what your potential income or job prospects could be first.
How to Decide What To Do With Your Windfall
Before taking any action with your new windfall, you’ll want to do the following.
Take a Minute
You don’t have to rush into any major decisions. Your windfall isn’t going anywhere.
Take the time to list out your options and weigh the potential pros and cons. If you’re in a relationship, be sure to include your partner in that discussion too since it will likely affect them as well.
Don’t Get Scammed
One of the worst things to do with new money is to fall for a “get rich quick” scam. This might be things like putting all your money into cryptocurrency, listening to bad financial advice online, or handing it over to some unknown financial representative.
In these cases, follow your gut. If it’s a path that you can’t understand or at a minimum explain to someone else why it makes sense, then that’s probably not the option for you or your money.
Pace Yourself
It’s easy when you’ve got newfound money to think you’ve got more at your disposal than you really have. This is why budgeting your money, no matter how much you have, is always strongly recommended.
If you’re not already, use a budgeting app like Buxfer to help keep track of your spending. Buxfer connects to all of your bank accounts and consolidates them into one real-time report. That way you’ll always know where you stand and if your finances are on track.
Receiving a nice large windfall can be a fairly rare event. For this reason, it is important that you carefully consider how it might be used to improve your situation. – whether that means paying off debt or pursuing other worthwhile financial avenues.
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