What to do with your Annual Bonuses?

It’s May. Apart from the heat, it’s also the season for your annual performance bonus.
A few of you may already have made plans for the use of this money as soon as it hits the salary accounts. But many of you must be wondering what to do with this money. Often this money gets spent in an unplanned manner and afterwards, you may repent and wish that you had used the money in a better way.

Here is a list of financially prudent things to do (in the order of priority) with your annual bonus rather than blowing it all up in one massive binge.

Build up your contingency fund – You should build up your contingency fund to at least 3 to 4 months of expenses in case you haven’t done that already. Building up a contingency fund is a crucial part of your financial plan. This contingency fund can be maintained in the form of bank FDs (try opting for sweep in sweep out option if your bank offers) or liquid mutual funds. Contingency fund comes in to picture in case of emergencies like job loss, illness or any other condition due to which one is not able to earn any sort of income for a few months.

Prepay your expensive loans – In case you are having expensive loans like credit card debt, personal loans, gold loan, loan against security, or such  where you are paying high interest rate, you should choose to utilize your annual bonus to prepay these loans and closing them even if there is a stiff pre-payment penalty. This will save you a lot of interest which you are going to pay in future. You can also consider repaying relatively lower priced loans such as home loans and education loans after seeking advice from your financial planner or tax consultant.

Tax planning – Most of you may try to allocate the money towards tax planning by buying tax savings mutual funds to get deductions under section 80C. Tax savings through equity based instruments should always be done systematically and never in lump sum. Investment in to equities should always be systematically over a period of time rather than putting money in lump sum. So, in case you are planning to invest the money into tax savings mutual fund schemes, you should keep the money in liquid funds or your savings bank account with sweep in and sweep out option and invest the money through Systematic Investment Plan (SIP)/Systematic Transfer Plan (STP) over the balance part of the year.

Save for your future goals – Keep this money aside for any goals you had in mind but you were not able to save enough or at all for the goal due to shortage of funds. You should invest this money wisely with an appropriate asset allocation between equity and debt keeping your time horizon in mind. In case your time horizon is sufficiently long (more than 5 years), a significant proportion (around 80%) of your bonus amount can be allocated towards equity based instruments. The remaining amount should be invested in appropriate debt products. Also consider balanced funds which give you this kind of asset allocation anyways with tax advantage to boot. While investing in equity products, please remember to do it over a period of time and not in a lump sum.

In case you have a goal which is just a few months away, for example, if you are planning to buy a home in time horizon of less than 3 years, then investment in equities is not prudent. You should choose appropriate debt products like bank FDs, Fixed Maturity Plans and Income Funds etc. for these kinds of investments. Also you should choose debt products in case you are awaiting any investment opportunity anytime in near future.

Of course a certain portion of the annual bonus can be used to go on that dream holiday that you have planned or that LCD TV or home theatre which you have been planning to buy. If at least a significant portion of the annual bonus has been used in the other alternatives, you can splurge guilt free on these kind of expenses.

Ideally you should sit with your financial planner and have a plan in advance on how to use the annual bonus.
Please do write in your views on how the annual bonus should be spent and whether most people plan for it in advance

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