A recent article in Money lists 43 ways to deal with an unexpected windfall – in the article’s case, a $5,000 windfall. There are a lot of good suggestions in the article that make a lot of sense to me, like paying off your highest-interest credit card debt or investing for the long term with the T. Rowe Retirement 2045 mutual fund or a Vanguard fund mix.
The only problem with such an article is that it overwhelms you with options. I went through the article and eliminated everything that didn’t apply to my situation and that still left me with roughly thirty options to choose from, and that’s if you only limit yourself to the choices from the article. How can you quickly evaluate and narrow potential options for a windfall?
Here’s the thought process that I would follow if a windfall fell on my lap.
First, do I have an emergency fund? I’ve written about emergency funds before, and I think it’s very prudent to have two months’ worth of salary for every dependent on your taxes in a savings account. For us, that means six months – and soon, eight months, and I’d like to eventually have more than that just to be secure. As an absolute bare minimum, you should have $1,000.
Second, do I have any high interest debt that’s outstanding? This also involves considering the deductibility of such debt – if you have a house loan at 6% but are in the 28% tax bracket, that means your true rate there is about 4.5%, decidedly not high interest. I use 7.5% or so as my “line” between high interest and acceptable interest, but others may find this line to be higher than that. I have no debts that are high interest, so if I got to this step, I’d keep on going.
Third, what are my biggest goals? If you close your eyes and ask yourself what you’d most like to do with the money in the future, what comes up? Try to think beyond a few months so that you’re not tempted to do something like buy a monstrous flat panel television. Do you see a wonderful vacation in a year? Do you see a house in five years? Do you dream of retiring at age 50? Each of those options tells you a different thing you should be doing with your money. Figure out what your most important goal is, determine how far off that goal is, and look for investment goals in that timeframe.
If I were to get a $5,000 windfall today, it would likely go entirely into an emergency fund, which would bring it close to a level that I want. I’d use any leftover money to work on my investment portfolio that’s geared towards building our dream home in fifteen years or so, or possibly towards a car fund that’s about three years off.