One fun personal finance thought exercise is to think through what you would do if you received an unexpected windfall of $10,000. Because it’s a neat experiment, we thought it would be a great way to kick-off the launch of Thriving Millionaires!
A few assumptions that we will hold constant:
1 The money is after-tax
2 The money is received today
3 There are no restrictions and no strings attached to the money
A few things immediately pop into my head relative to this thought experiment, but first a little background on how we cooked up this idea. $10,000 is a lot of money, but it isn’t necessarily life-altering, which makes it the perfect amount to play this game with. If the sum was $100, the answer might be as simple as “Have a nice dinner out”. And if the sum was much larger, say, winning-the-lottery size, many people would answer “Quit my job” or “Retire”. That makes $10,000 the perfect amount – it’s large enough that it warrants a significant amount of thought, but not so large that it removes the gravity of how you may use it.
$10,000 is also a great amount for this question, because it isn’t an amount that is out of the question for things like bonuses from work. A December 2018 survey of 500 businesses in the US found that the average bonus payout is a little less than $1,800, so the $10,000 is certainly larger than the average, but not so far out of line that the theory goes away.
My first thought would be to ensure I had a sufficient amount of money in a highly-liquid format for my emergency fund. Generally, you’ll hear that you should have somewhere between 3-6 months’ worth of living expenses saved, and I am personally on the more conservative side of the argument. So, I would first ensure that I had 6 months of expenses covered in cash at a mid- to high-yield savings or checking account.
Because I already have that safety net in place, I would move on to my next thought, which would be to project my upcoming large expenditures. If I was planning to buy a house, a car, furniture, etc, in the next few months, I would hold the money in a savings account. If I had a definitive time-line associated with this purchase, I could contemplate putting the money in a CD, but without a certain timetable, I would leave the money in an easily accessible account with no withdrawal penalty.
Knowing that I don’t have any large upcoming expenses, I don’t have the need to leave this money in an easily accessible account. The next thought I would delve into is the investigation of my current debt obligations. I would review where I owe money and the current interest rates associated with those loans. This would be a great time to pay down student loans, credit card debt, auto loans, etc. Even if the $10,000 didn’t allow you to pay off the entire amount, it could potentially shave a significant portion of the interest expense off of the life of the loan. For example, if you owed $25,000 on an auto loan at 5% interest over 60 months, you would end up paying over $3,300 in interest. However, if you could reduce the outstanding amount to $15,000 by applying the $10,000 against the outstanding balance, you would pay a little less than $2,000. This $1,300 savings would certainly be worth considering!
Because I am in the fortunate position to not be carrying any high-interest debt, I would start looking at areas to invest the money in the market for long-term growth. While the markets have been soft lately, over the long-term, investing in stocks or bonds is one of the best ways to build wealth. I would evaluate my current asset allocation and invest accordingly to ensure I’m balancing my equity holdings with my bold holdings given my current stage in life and my risk profile.
Of course, there is an aspect to the fact that this is “found money”, so there is a high likelihood I would use some of it for a little fun with my family. I would take a percentage of the $10,000 to spend on a family vacation to make memories and have experiences that will last a lifetime.
My likely course of action for the funds:
$2,500 on a family vacation
$3,500 invested in an S&P 500 ETF
$2,500 invested in an international ETF
$1,500 invested in a diversified bond ETF
Ten thousand dollars? Sounds like a great deal of money whether you’re a college kid or a young professional fresh out of school. Even for a successful businessperson, an unplanned ten thousand dollars seems like a great win. I like to call this the relief effect. When we receive something we weren’t planning for, it’s easy to spend it on extravagant things that we may otherwise not have. As a new salesperson right out of college, this is how I often treated my annual bonuses. I would plan an elaborate trip with friends, buy a nicer car, or invest in a home improvement project that before had been out of my regular budget. Since ten thousand dollars doesn’t seem like enough money to really make a difference, why would I apply it towards my large outstanding mortgage or car payment? I’ve already got a realistic plan for those, so I might as well just stick with it.
This is the problem with a windfall that is large enough to raise eyebrows, but not large enough to significantly make a dent in our major obligations. Since we have monthly financial obligations, we don’t plan for the long-term impact decisions today could have on those plans down the road. For example, let’s say you have just signed a mortgage with the below terms:
Mortgage Amount: $250,000
Interest Rate: 4.5%
Mortgage Term: 30 year fixed with no pre-payment penalty
Annual Property Taxes and Home Insurance: $3,500
By making a one-time lump-sum payment of $10,000 in additional principal on your first payment, you could save yourself $26,507 in interest payments over the course of the loan. Even better, for the last 2 years and 4 months of your 30-year term, you would have no payments. Now, some will argue that you could invest that money into an index fund, retirement account, or something else where you would generate even more returns. That is certainly true, and if that opportunity exists, it should certainly be taken. Another consideration is how long you plan on being in that house. If you’re not planning on being their long-term, it certainly may not make sense. If you plan on being there long term, you are GAURENTEED to save that amount of money, even if you just make the standard payment each month after that. They key point is that even though $10,000 might not make a big dent in a major obligation, you must access the long-term implications of using that money today to buy cash-flow generation in the future. Whether that’s your mortgage, student loans, a car payment, or simply investing, $10,000 can jump you ahead years in your goals.
But what fun is getting a whole bunch of money and not getting to do anything special with it? This is where I get to my 80/20 rule. Simply put, 80% of any major windfalls ($500 or more) that I receive go towards long-term financial planning or obligations. The other 20% is fun money that my wife and I get to enjoy. Major windfalls happen more often than you think. In the past year, I can count several that we have experienced: annual bonus, tax credit, wedding presents, Christmas presents, selling of old home items, etc. The important thing is, don’t let the rewards of today not continue to serve you in the future.
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