How to deal with an unexpected windfall

Image of a present - how to deal with unexpected windfallsBack in the dim and distant past, a windfall referred to wood or fruit which was blown down by the wind and so became free to anyone. It was later in the 16th century that the term was used for any unexpected acquisition of wealth. Here are some thoughts on how to deal with unexpected sums of money.

Now, I’m partly writing about windfalls because this month I received both a bonus at work as well as a pay increase which takes effect next month. I consider both of them to be windfalls since I don’t plan on receiving any.

As with all Personal finance guidelines there are no absolutes, since everyone’s situation is unique. Even the amount of the windfall can influence the decisions to be made. So here are some general comments, along with the specific plans that I made with my windfall.

Save half, spend half

It’s certainly tempting to rush out and spend all the money on things you’ve wanted for a long time. Especially since you hadn’t planned on receiving the money in the first place.

Now, imagine that you’re on a long car journey and the speed of your car is limited to 30 mph. Spending all the new money is equivalent to sprucing up the interior of the car or having some new toys to distract from the slow progress. You won’t be arriving any sooner. Consider putting some money towards speeding up the car instead, so that you reach your destination earlier.

A great rule of thumb for any new money received, is to spend half and save half. This allows guilt-free spending of half of the money, but keeps some held back in reserve. Of course, the money saved should be long-term and not spent immediately in the following month.

Make it count

An old saying goes: one person’s trash, is another person’s treasure. Or something like that. There are no right or wrongs about how you should spend your money on “wants” rather than needs. But, some things have more value than others.

Experiences, improving your quality of life, your family, education or self-improvement all generally have more value than short-term escapist items. It’s entirely up to you on how to calculate their value, but when spending money, try to make it count.

And if you have a financial plan, that should pretty much tell you where to spend the money.

Paying down expensive debt (i.e. debt with a high interest rate), or building up an emergency fund also makes sense depending on your situation.

Keep an eye on lifestyle creep

In the case of a higher salary, the same reasoning applies. Just because you’re paid more doesn’t necessarily mean all the extra money per month should be spent. There’s nothing wrong with spending more, but also try to save more.

The good thing is that both increases naturally follow if you track savings rate as a percentage of your income. Keeping your savings rate at 50% provides more money for spending and more for saving when your salary increases. But it may well be that 48% of the new salary still provides a large enough increase for spending, that you can now save 52% of your income.

Also look out for purchases that increase monthly spending. An extreme example of this might be an expensive car which requires higher license fees, insurance and most likely, maintenance. Even a cheap High-Definition TV might drive the need for higher monthly cable TV bills.

Investing my bonus

In my case, once taxes are all taken care of, I will be receiving about $20k at the end of this month due to company and personal performance at work. Here’s how I will be using it:

Investing in Income Fund: $15,000
Long-Term Savings: $3,000
Spending: $2,000

I don’t believe in holding spare cash as part of my Income Fund, so I’ll be investing the money as soon as the deposit reaches my account this week. It’ll be split between US Shares (VHDYX), International Shares (VIHAX) and Intermediate Bonds (VBIIX) which are the underweighted assets in my portfolio. Most of the purchases will be in VHDYX. This should provide about $500 additional income per year.

Long-Term Savings will be a mixture of cash ($1,000) and the remainder in my house-payoff account (VWELX).

Finally, I’m putting aside about $2,000 for spending. I’ll add this money into my Savings account for the short-term. And, since this is an usual thing for me, I’ll be writing about this in a separate post. Stay tuned!

Salary increase

I received an above-inflation salary adjustment. I don’t know the full impact of the new amount yet although I’ve estimated the effect of taxes and social security.

Two steps I’m making are to withhold more taxes from my paycheck to help offset my dividend-income, and to increase my 401k contributions by 1%. I’ll review how to use any left-over money once I get a feel for the amount, but it’ll likely be split 50:50 between investing in my Income Fund and adding to my long-term Savings.

Conclusion

The size of year’s bonus amount was quite unexpected and will be a couple of extra steps towards Financial Independence. I don’t expect to receive any bonus, so clearly this extra amount will help me reach and exceed my goals.

I plan to spend about 13% of the bonus; the rest will be invested / saved.

I don’t plan to increase my living expenses based on my new salary so my savings rate should increase a little starting in March. I had already increased my living expenses a little this year based on my Budget 17.0 so I can save the pay increase instead.

Did you receive any windfalls recently? How did you put the extra money to use?


Quote of the Day

Try not to become a man of success, but rather try to become a man of value.

4 thoughts on “How to deal with an unexpected windfall”

  1. Congrats on the bonus DL!! 20k is an large sum! Was this a commision or a thanks for a job well done? That’s very smart of your to put it towards your income fund.

    I got my yearly bonus this past Friday (only 7k :)) I’m going to contribute to my Roth IRA for 2016, and continue to build savings for a house or other investment.

    Congrats again and looking forward for the next post on your unusual short term cash spending!

    1. Hi Erik,
      It’s a company policy – they tend to pay lower annual wages but everyone gets a percentage of the profits, with a higher percentage for higher positions. It seems profits were good this year 🙂

      Putting your bonus towards your Roth and saving the rest is awesome! I chose not to put my bonus into my 401k, but if I could pay into my Roth IRA I definitely would.

      My unusual spending is certainly raising some eyebrows so it should be fun writing about it!
      Thanks for stopping by!
      -DL

  2. Hi DL,
    Indeed congratulations in your bonus. That is a great amount and even better that you did not plan on receiving it. Was it really unexpected or did you just not budget for it? Either way, great that you will be able to save a lot of it. The salary increase sounds also very good.
    The company that I work at is currently trying everything to reduce costs. I did not get a salary increase for example. So inflation adjusted I’ll earn less this year vs last. So, no windfalls here unfortunately. Even more reason to work on my dividend income.
    Regards,
    DIB

    1. Hi DIB,
      The bonus is likely but isn’t guaranteed, nor is the amount since it depends on a number of factors: company performance, personal performance etc. My company tends to pay a lower base salary but supplements it with a variable performance portion; that way if the company has a bad year they have a bit of control over wages without officially having to reduce salary. So I don’t make my plans on getting a bonus and I don’t want to get into a “spend it before I receive it” mindset either.

      The salary increase is nice as it’s above inflation. My investment income is a higher percentage increase, the same as you and it’s great getting raises every quarter!
      Best wishes,
      -DL

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