There are at least a couple of times in the year when a few of us provided with an influx of cash. I am talking about year-end bonuses or tax refunds or even small gifts etc. So, what should you do if you do receive a lumpsum amount? I’ve come up with this step-by-step approach based on my own Personal Finance 101s.
Understand and potentially clear blockers to your Primary source of Income
Let’s say your current vehicle breaks down every few days but this is a critical requirement for you to get to work. This is the only time you will hear me say buying something is a good idea. Try and buy the vehicle on as little debt as possible by making the maximum down-payment you can. If you work from home and you’re A/C or furnace keeps breaking down, allocate the lumpsum amount to this purpose. Bottom-line is remove smaller capital expenditures that potentially get in the way of you being able to deliver your daily best.
Pay-off High Interest Debt
If you have high interest debt on credit cards, pay-day loans or other non-mortgage items, consider paying them off. Most Personal Finance practitioners and advisors would likely agree to this. Paying off high interest bad debt is a crucial first time to achieving financial independence.
Continue building your Emergency Fund
Use the lumpsum to boost your emergency fund. You could consider building a fund that covers all your bills for at least 3-6 months were you to lose your primary source of income. Some even consider emergency funds of up-to 12 months but keeping a very large amount of cash in your Savings account may not be the best bet in times of severe inflation.
Get Compounding to work for you – Equities, Mutual Funds, ETFs etc.
Consider this only if you do not have high interest debt or any blockers to your primary source of income. Long-term investments in the stock market through low cost ETFs, mutual funds or even stocks is a great way to counter inflation. If you are already investing, consider adding more to your portfolio. There may benefits to lumpsum investing in the market as certain studies have shown historically. Be cautious while investing. This is even better if you have room in your TFSA accounts where you hold currently hold these investments. Allow compounding to do this thing for you !
Maximize your tax savings through channeling funds into your RRSP
Personally, I would like to max out my TFSA contribution before investing into my RRSPs. But adding a portion of your lumpsum to your RRSP maybe a good idea if you have allowable contribution room for the year. You potentially end-up paying lower taxes at the end of the tax year. More on RRSP in this blog here.
Save money for your Primary Residence, Rental, REITs or Crowdfunding opportunities
If you have compounding working for you and are also maximize your RRSPs each year already, consider saving some money for real estate investments. Millennials are finding it more difficult than ever to purchase their first home in Canada. If you have a short-term goal of owning a primary or a passive income property, then consider saving the lumpsum for this purpose. If you don’t want the hassle of owing a passive income property (maintenance, dealing with tenants etc.) consider crowdfunding for real estate or REITS. This could give you exposure to another asset class.
Spend some money on experiences or your Family
Yes, you got it right! If you’ve done a lot of the above recommendations, consider taking a vacation or spending the money on your family. If you’re planning a vacation, a portion of the lumpsum maybe helpful in booking flight tickets. Of-course, earlier booking may hep you with better travel rates etc. If your family is your getaway then spend a bit on your family. If you haven’t put away money for your children in a RESP account for the year, that could be another thing you could do.