After you pay your bills, what do you do with money you have left over? This could be a one-off as you just received your tax return or a lump sum of cash or maybe this is your new normal after earning a raise at work. Either way, there are different decisions you can make with excess cash to support your financial goals such as paying down debt or starting a new savings or investment plan. Each option comes with different pros and cons for you to consider.

Deciding what to do with your money can be tricky and is going to vary from one person to the next, but you can walk through these steps to determine what might be best for you in the long run.

Start from the beginning – income and debts

To get started with a plan specific to you, you need to assess your situation as realistically as possible. If you haven’t yet, sit down and create a budget. This will show you exactly how much money comes in and goes out each month. It may even highlight some places for additional expense cuts.

The second part of creating a budget is to list out any debt you have, as that is part of your full financial picture. List out debts with their accompanying interest rate so you can determine which debts are the costliest. For example, if you have a zero-interest 12-month financing plan on a piece of furniture, that isn’t going to be as high of a priority to pay off as a credit card debt with 5% interest.

Typically, focusing on high-interest debt first is your best bet in the long run, but there are various ways to pay down your debt.

Make a roadmap

In a 2021 Consumer Financial Protection Bureau experiment‡ participants were given a hypothetical situation of a man with $5,000 in credit card debt. Each group of participants were given different amounts that he had in his savings account. The groups were then asked what they would suggest the hypothetical man do to improve his finances. Findings from the study showed that most people suggested paying down the debt, but that many also preferred to keep a cushion in their savings. If that resonates with you, that’s okay! Maybe you can do it all – just not all at once.

Decide what plan is going to work best for you. Maybe this year you want to work on eliminating as much debt as possible and next year you want to really build your savings. Or for the next six months you want to see how any extra savings can do in a high-yield savings account and then tackle debt. Sit down and take some time to think through what you’d like to accomplish and then choose your path to get there. Here are some considerations.

If debt elimination is your primary goal:

  • Implement the 50-30-20 rule. This can help provide some guardrails with your spending, especially if you are a first-time budgeter. This rule says that when you get your paycheck, put 50% towards essentials like your mortgage and car payment. Then, put 30% into things you want to buy like dinner out or entertainment, and finally the last 20% goes into your savings or to pay off debt.
  • Avalanche or snowball debt repayment. These are two debt repayment methods that provide guidance based on what works best for you. The avalanche method suggests you pay towards the biggest debt you have (while still making minimum payments on other debts), so that you can get it off your plate the fastest. Once that is paid off, you move on to the next largest debt. The snowball method is the opposite, where you start by putting extra money towards your smallest debt and working your way up to larger debts. If you want to feel accomplished quicker, this method may encourage you to keep going.

If saving is your primary goal:

  • Set up a direct deposit. This may be a way to work on your debt and build your savings simultaneously if that is your goal. You can set up a portion of your paycheck to go into a separate account for savings. This can help you sock money away without you even realizing it, and you can continue to use any extra cash to pay off your debts.
  • Try a new savings vehicle. If you want to ramp up your savings with a lower risk, consider opening a high-yield savings account, Money Market or CD account. Each of these options offers different benefits and restrictions that you can consider in order to keep your savings growing.
  • Don’t forget retirement savings. You never want to discount your retirement savings for other priorities. Always ensure you are contributing enough to earn your company match, if offered, on your 401(k) so you aren’t leaving any money on the table. Thinking of your future self is just as important as thinking of yourself right now.

It is also a possibility to combine several of these options to create your perfect financial menu.

Don’t be foolish with extra cash

It can feel so good to have extra money, but one of the biggest mistakes you can make is getting into the habit of emotional spending or telling yourself “I have extra money to spend.”

You also don’t want to rush into anything. When it comes to investments, there are many options to consider.

If you are looking to try something new with your extra cash, consider your investment persona and dive in. Once you have a solid financial foundation you can explore broadening your portfolio and trying riskier investments for a higher return.

It’s best to plan ahead, follow your path and be thoughtful with your decisions.

Remember – any growth is good

Budgeting and saving are a wave you are going to learn to ride for the rest of your life. Your plans will ebb and flow as your circumstances change, so plan to revisit your savings roadmap often. Different life events will trigger changes to your financial plans as well. Marriage, children, a new job, an inheritance windfall will all impact your long-term financial goals and strategies.

To evaluate your growth and make adjustments, there are various budgeting apps out there that can help you along the way or you can stick to a pen and paper method. A banker can also help you determine what strategies above might work best for your specific financial situation. In addition, Also, consider working with a financial advisor who can help you review your financial strategy annually and make shifts specific to you. Once you have a plan in place, you’ll have your roadmap for any future income spikes that may come your way.

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