Hey Reader,

One of the most common questions I answer is, "What should I do with the cash from my bonus, inheritance, etc.?"

While there's no one-size-fits-all answer, this framework can be used in every instance.

Sorry, we have to start with the least exciting one...

Prepare for Taxes

It's hard to spoil the joy of a cash influx, but failing to plan for the tax bill is the easiest way to do it. I've seen it happen numerous times.

It's April of the following year, and you've already spent the cash, paid down debt, or invested it for the long term. You file your taxes, and your heart skips a beat as you realize you underestimated the tax bill.

The best-case scenario is you sell investments and recognize capital gains or have an emergency fund to pull from. The worst-case scenario is you don't have spare cash and you're forced to sell investments at a loss.

Neither scenario is ideal. So, the first thing you should do is determine how this sudden wealth will affect your current year's tax liability.

Get clear on your projected tax liability compared to your withholding and set the difference aside in a high-yield savings account.

Also, don't assume your employer will withhold enough taxes.

Federal taxes on the first $1,000,000 of supplemental income, like bonuses and equity comp are withheld at 22% but taxed as ordinary income at your marginal tax rate(s).

If you're in a higher tax bracket, there will be a gap between the tax withheld and the tax you owe.

If the windfall is from a liquidity event or sale of stock, you likely need to account for a substantial capital gain with no tax withholding.

Address Cash Reserves and/or High-Interest Debt

If you’ve neglected your emergency fund up until now, use this opportunity to buy yourself some security and peace of mind.

If you already have an emergency fund, revisit your cash flow to ensure it’s adequate for your situation. Determine your total monthly expenses and set aside the amount of cash you're comfortable with. Here's a rule of thumb:

• 3 months of expenses - dual-income households with comparable earnings contributions and potential.
• 6 months of expenses - single-income households or those where one spouse has most of the financial responsibility.
• 6-12 months - business owners, sales professionals, and other professions with variable income.

^Remember that these are simply rules of thumb and need to be adjusted for your situation and preferences.

High-Interest Debt

We live in an era where more than half of people earning more than $100,000 report living paycheck to paycheck.

So, it’s not uncommon to see high-earners carrying credit card balances. If that’s you, this is the perfect time to get rid of it.

Paying off high-interest debt can free up cash flow and reward you for years to come.

You may swap the priority of cash reserves and high-interest debt or split cash between both.

Now, let’s start giving the cash a purpose…

Plan for Short or Intermediate-Term Goals

One of the biggest mistakes I see people make is not planning for anything beyond next week, let alone years down the road.

This is your chance to avoid scraping cash together at the last minute for a new car, home purchase, etc. or being forced into unfavorable loan terms that make the purchase unaffordable.

Earmark money for planned expenses and invest (or don't invest) the cash using an appropriate risk profile according to the timeline for using the funds.

This is another great rule of thumb from Larry Swedroe. The chart outlines how much risk you should take based on the number of years until you need the funds. You can read his three-step asset allocation series here.

Analyze Other Debt & Long-Term Investments

Long-term investing/debt management should always be a priority when we have excess cash.

However, we address steps 1-3 first because they help us stay in the game over the long haul, which is the most important factor for success.

Now, you can consider:

• Investing funds for needs 10, 20, or 30+ years away
• Paying off a portion of your mortgage, student loans, or other debt

Or a combination of both.

Depending on your debt’s interest rate, it may make sense to pay down the principal for a guaranteed risk-free return.

Or maybe you expect the long-term return of your investments (dependent on your asset allocation) to exceed the interest rate.

Remember that the quantitative answer isn’t the end-all-be-all.

Evaluate how each approach will affect your long-term financial plan.

If there isn’t a material difference, go with the option that’s most comfortable and helps you sleep better at night.

Treat Yourself!

Don't forget to reward yourself for your hard work.

The best thing you can do is find the balance between using money to address your future needs while living a life you don't want to retire from.

That's what financial planning is all about.

Conclusion

One of the best ways to improve your financial situation is to give every dollar a purpose.

I hope today's email helps you do that.

As always, please reply with your questions and feedback!

-Matt Garasic

P.S. If you...

• Want practical advice on how to reach your financial goals
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Disclaimer:

This is for general educational and illustration purposes only. This should not be taken as individual investment, tax, or legal advice.

Consult your legal, tax, and financial team before implementing any financial strategies for your specific circumstances.