You're in the Money - Sensible Places to put your Bonus
It's the moment you dreamed about all those late nights while slurping Ramen noodles with your head in a book.
Your boss announced your first bonus. Now what?
Do you use the entire thing to pay off loans, invest it all in mutual funds? Do you ignore the conventional wisdom and blow the wad on a villa in France?
Here's how to use your windfall in a sensible manner. Since Vault asked financial experts only for responsible advice, there will be no more talk of France. (Sorry.)
First, no matter what you do with your money, it helps to learn the basics of financial planning and investing, says Beth Kobliner, author of Get a Financial Life: Personal Finance in Your Twenties and Thirties. Too many young investors learn the hard way, she says.
"A lot of people right out of law school or an MBA program have spent a huge amount of time studying and are now in a job where a $40,000 bonus or a $100,000 bonus means you're probably working 80- or 90-hour weeks," says Kobliner, whose financial-help website, Kobliner.comoffers advice to the newly-bonused. "So even though they have more money than they've ever had, they also have a lot less time than they've ever had.
"[Some] fall into a trap of either keeping it in a checking account because they're too busy to pay attention or handing it over to some broker who ends up charging excessively high fees that whittle away at that bonus."
Learning the basics can take an hour or two a week, says Kobliner.
The first and most sound place to park your money is in a tax-deferred retirement savings plan, like the 401(k) plan you are likely being offered at work. Because you don't have to pay taxes on the money, you'll make more money. Max out the account, say the experts. The biggest before-tax contribution you can make this year is $10,500.
Next, tackle your debt if you have some, or especially if you have a lot. That may include school loans, credit card and department store charges accumulated since freshman year on top of the newer bills for interview suits, apartment furnishings and moving expenses. Paying off the high-rate debt should be your priority.
~ "It's a very expensive time in their lives," says Lee Rosenberg, a Long Island-based certified financial planner. "If they clean up a lot of those debts, it makes monthly living expenses a lot easier."
Since big bonuses look far more modest once taxes are taken out, Rosenberg also suggests establishing an emergency fund.
"If you're spending more than you're earning, which is possible during the first-time job, you have some money for emergencies throughout the year," he says.
Another unpleasant factor to consider about bonuses is "bracket creep," says Paul A. Levis, of Summit Financial Consultants Inc. of Yonkers, N.Y.
Sound scary? A bonus could put you into a higher tax bracket. If so, you will owe more money than the government has been withholding. If your company doesn't withhold the taxes on your bonus, or you find yourself in a higher tax bracket, you should stash the money you will owe for state and federal taxes in a money market or savings CD for three months until you do your tax returns.
With the money you have left to invest, you should first consider your goals.
Even if you've been waiting forever to buy a new car, a Hawaiian vacation or a down payment on a house or co-op, you should not subject your hard-earned bonus to market risk, says Levis.
"Park it in a money market account," he says.
According to Kobliner.com, a money market is nearly as safe as bank accounts but with higher returns, these funds consist of an ever-changing collection of very short-term loans to large, stable companies or governments. Also called "money funds," they are nearly as safe as bank accounts but with higher returns.
Finally, you're ready to start investing the money wisely. The experts are at odds over whether you need to seek outside help.
Michelle Lanyard, a Boston-based Investment Advisor Representative, recommends finding an independent investment advisor or tax consultant to help manage a large bonus.
"I'm amazed at how many people try to [manage a bonus] themselves and end up in a mess," Lanyard says.
Kobliner says new investors don't necessarily need outside help. Even if your bonus is $150,000, it's not a huge amount in the grand scheme of the American economy - or in the universe of financial planners. The personal planner you work with likely will not be "some fantastic hedge-fund genius" but someone who will direct your money into mutual funds you could also find on your own.
~ Kobliner favors mutual funds because they include hundreds, if not thousands, of different stocks. Essentially, they allow you to lower your risk by spreading your money around, she says. That way, if some of the stocks in a mutual fund become worthless, other, higher-performing stocks should compensate.
"A broker is a salesperson who's out there to sell you stocks," she says. "They might not be the best investment for you. A lot of people end up getting burned."
Young investors may end up squandering their bonuses, she says, by rushing into the stock market with the hope of making a killing on high-growth stocks without considering basic investment wisdom.
"What I've seen in the last few years, with the whole Internet technology boom, is a lot of young people who are under the misperception that they want to put all their money into aggressive tech start-up companies" she says. "True, if you had put your money into AOL when it first started in 1992 or Yahoo in 1996, you would have done incredibly well. But plenty of start up dot.coms are having lots of trouble right now, and a lot of young people who poured their money there face a rude awakening."
Another young-investor trap, says Levis, is the rearview mirror effect.
"They will read the latest issue of Money magazine and look up the best-performing funds over the last three months, six month or one year," he says. "They tend to invest using the rearview mirror more than by looking forward."
With enough money to invest, the bonus could be split into several mutual funds, says Rosenberg, co-founder of ARS Financial. He suggests putting some money into a taxfree bond fund, typically low yield but useful for paying off April taxes, as well as a more strategic blue-chip fund. For more aggressive growth, he suggests taking advantage of the current NASDAQ turndown by buying into technology and biotechnology funds, as well as giving a hard look at international funds.
Young investors should lean towards the aggressive side, says Lanyard.
"Twenty-somethings have more time to be invested and as long as they are in the market for the long haul, they should be able to tolerate fluctuations," she says.