If you were lucky enough to land on your company’s nice list this year, continue being a good girl or boy and consider investing your holiday bonus.
According to data from financial services provider TIAA-CREF, putting a significant lump sum to work in the market usually returns better results than dollar-cost averaging.
For all rolling 12-month periods starting each month from January 1926 through August 2014, the financial services firm found that a lump sum invested in a portfolio of 80 percent stocks and 20 percent bonds delivered greater returns than dollar-cost averaging the same amount of money over three-, six- and 12-month periods a majority of the time. Even better, in a portfolio of 20 percent stocks and 80 percent bonds, the lump sum investment beat dollar-cost averaging even more.
Furthermore, according to the report, “while dollar-cost averaging would have offered some protection in negative markets … the advantage was significant only when there were extreme downturns. In the overwhelming majority of periods, the advantage of dollar cost averaging, when there was one, was small.”
That’s not to say that the only time to invest is once you’ve accumulated a large sum. Especially if you’re just looking to get started, any small amount is better than nothing. But your holiday bonus presents a unique opportunity to invest more; it’s not every day you score a significant amount of extra income, after all.
Still, investing your windfall might not be the best financial move for your particular situation. Before you do anything with your bonus, be sure you have a plan in place. “People who strategize tend to be much much much more successful than those who don’t,” said Joe Eppy, president of financial firm The Eppy Group, based in Fort Lauderdale, Florida. “Actually sit down and think about it. Don’t just start reacting to it because you’ve got this check.”
A better move for you might be to use the extra cash to tackle yourcredit-card debt. In fact, financial planner Shanda Sullivanrecommends putting half of your bonus toward paying down debt. If you’re carrying a balance and being charged interest every month, you’re diminishing your net worth. And with even so-called low-interest credit cards charging an average 11.67 percent rate, according to Bankrate, your investment portfolio is not likely to grow at a pace that would offset those losses.
Plus, the faster you clear away high-interest credit-card debt, the sooner you can cut that cost out of your budget and use the money usually allocated to paying off credit cards in another way. “By reducing your credit-card debt, you can free up some positive cash flow and add more to future savings,” said Eppy.
Another option for using your bonus wisely is to directly add to your savings, whether it’s for retirement or more short-term goals such as buying a house or car or saving for college. Sullivan recommends using a quarter of your bonus for saving.
Also consider giving a portion of your additional earnings to charity, recommends Eppy. On top of the philanthropic rewards, you can earn a tax deduction for your donations. “And be cognizant of your company matching money on charity, so you can make the world a better place,” he said.
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Finally, think about using your extra income to treat yourself. “When you allocate a portion to savings, debt and spending then you will feel as if you’ve accomplished something but still satisfy the portion of your brain that wants to have fun with the extra income,” said Sullivan.
Eppy agreed that “it’s important to spoil yourself” a little bit, but only after your other financial priorities are met. “There’s more to life than just making money, so it’s important to reward yourself along the way,” he said. “When you know you’re saving enough to reach your goals … it’s more fun and more enjoyable to spend the rest of it because you know it’s not disrupting that part of it.”