Having extra funds is a great problem to have. However, deciding what you should do with that excess cash can be tricky.
Determining the best place to put the money or how to invest extra money can be overwhelming. In some cases, learning how to use your money effectively can be so daunting that you simply do nothing with your extra cash. Unfortunately, this is often the worst way to handle extra money because you are not putting it to work for you.
It can be tempting to just buy something else for your home or “treat yourself,” but that often is not the best use of your extra funds. Instead, if you want to be smart with your money, you might want to use it for savings, investments, or to pay off debt. The best option for you will depend on your unique personal and financial situation.
A cash surplus or surplus cash flow occurs when the cash on hand exceeds your budgeting needs. That surplus can occur over a few weeks or even over a period of a few years. While you commonly hear cash surpluses as part of business operations, they certainly occur in personal finances as well.
Excess cash generally appears in one of two ways: over time or suddenly. Spare money can appear over several weeks, months, or years of simply spending less than what you are earning. After several periods like this, you may take a look at your bank account and realize you have a chunk of money sitting in that account, often gaining very little interest.
Extra cash might also appear because of a gift, inheritance, legal settlement, or bonus from work. In this type of situation, you may suddenly have extra cash instead of watching it build over time.
A cash surplus occurs when your income is more than what you need to cover your expenses. Regardless of whether this money built up over time or it appeared suddenly, the first thing you should do after you realize you have some excess cash is to take a look at your budget.
One potential issue that might arise if you have extra cash is that you forgot to make a payment on an outstanding obligation. Simply forgetting a payment is common, but you should also be sure that your recurring payments are still being made as they should be. In some cases, recurring payments that need to be paid (such as the mortgage or car payment) might not go through if you got new card or account information.
Before you get excited about using your newfound surplus, be sure that you have not already earmarked that money for something else.
Reviewing upcoming expenses can be an excellent way to save money and get ahead of your payments. For example, are there savings that you can obtain by paying expenses now instead of waiting until they come due?
Car insurance is a good example of this type of expense. In many cases, if you are currently paying your car insurance monthly, you can often get a discount if you agree to pay for coverage for six months or a year at a time. If you suddenly realize you have extra cash, agreeing to pay upcoming bills in advance can save you money, especially on items you will have to pay anyway.
If you have outstanding debt, you might also want to make some advance payments on those obligations, including credit card payments or car loans. Taking care of those outstanding debts with your extra money can be a great way to save on interest and fees.
One sometimes overlooked aspect of budgeting involves examining how much you are giving to charity or other causes. Suppose you have a sudden and significant cash surplus. In that case, you might want to consider donating a portion of it to cut down on your tax obligations associated with receiving the payment. Your financial and tax professional can help you decide if this type of situation applies to you and the best way to donate from a tax perspective.
Having an emergency fund or rainy-day fund that you can access quickly is always a good idea. This money should sit in a savings account or money market account that you can reach fast—so there is no delay between the time you need the money and the time you can get the money.
A good rule of thumb is to have three to six months of expenses saved in a high-yield savings account or money-market account. The more unstable your employment or income, the more your emergency fund should lean toward the six-month expenses mark.
You might also want to take this time to review your risk management plan as well, including things like auto insurance, life insurance, and disability insurance. If you need more coverage, you can use your extra funds to get the coverage in place that you need.
Alternatively, if your surplus cash is significant, you might want to consider using those extra funds to replace a specific type of insurance. For example, if you have $100,000 in a money market account, you might want to consider dropping or decreasing your auto insurance coverage if that is all the coverage you have in place.
The three most common ways that individuals use excess cash (apart from spending the funds outright) include:
The best use of these funds for you will vary a great deal based on personal preference and financial goals.
In general, it is a good idea to pay down your debt first. However, if you have an extremely low interest rate on a debt obligation and you can get a better interest rate on an investment, it might make sense to invest rather than pay off your debt. Keep in mind that these situations are rare—in most cases, paying off your debt is the best use of excess cash.
If you have reviewed your budget, made adjustments as necessary, and still have money left over, you might wonder: Where is the best place to put the money? How do I invest the extra money?
If you plan to use the funds within the next 12 months, it is probably a good idea to keep the money liquid. Using a money market account or high-yield saving account will allow you to have access to the funds while also making them work a little bit for you.
Potential short-term uses for these funds might include things like:
Waiting to use these funds for something that you were going to finance can be a great way to save on interest expenses.
If you have considered all of your upcoming expenses and cannot think of something that you might use the money for in the next 12 months, you might want to consider your “medium-term” goals. These goals are a few years out, and they might be specific, or your goal might simply be to get a higher return on your extra money.
Investing is a great option when you have at least two years to watch the money grow. You can work with a financial professional to develop an investment plan that works well for your risk tolerance and overall goal for these funds. With proper planning, you can also have access to this money when and if you need it.
Another option that might be considered a “medium-term” investment is to open a health savings account. An HSA account works in conjunction with a high-deductible health plan. You can save money to cover healthcare expenses, and those savings will grow tax-free. You can contribute up to $3,600 in 2021 for individuals or $7,200 for family coverage. If you are over the age of 55, you can also use “catch up” contributions of $1,000 per year. These funds do not have to be used within a certain period, so you can use them immediately, over the next few years, or even well into retirement.
You can often get the most bang for your buck if you commit to investing it over the long term. Investment strategies that are focused on long-term goals (like retirement planning) will usually have the highest rates of return over time,
Some examples of long-term investments that you might want to consider include:
Working with a financial planner is one of the best ways to determine how you should use your spare money effectively. A good financial advisor will work with you to learn your goals and develop the best plan for you to meet them. The team at Dechtman Wealth is ready to work for you. Contact us for more information or to schedule an appointment.