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Ask Bankable: Should I Save My Bonus Or Use It To Pay Down Debt?

By: forbes.com 2 months ago
Ask Bankable: Should I Save My Bonus Or Use It To Pay Down Debt?

I just received a year-end bonus. Is it better to use it to pay off my credit card or should I put it in savings?

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Dear Ask Bankable:

I just received a year-end bonus. Is it better to use it to pay off my credit card or should I put it in savings?

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Money Master says:

First of all, congratulations on your bonus! You’re wise to be thinking about the best way to deploy it. Since most credit cards have sky-high interest rates (the national average is around 16%, but rates can stretch to 24.99% or higher for certain borrowers), your priority should probably be paying off your balance.

"Think of it this way: that debt is growing (with a high interest rate) much faster than the savings ever would," says Patrick King, founder of Transformative Financial Planning in Atlanta, Georgia. Consider the math. If you’re paying 16% on your credit card, you’d have to earn 16% on your savings or investments to keep up.

That’s unlikely to happen: Your bank’s savings account probably offers an interest rate that’s close to zilch and even the best national online savings accounts only tout 1.3%. Meanwhile, the long-term annual return for the S&P 500 is around 7% when adjusted for inflation.

"You always want to think about where your money is working the hardest," says Melissa Sotudeh, a financial advisor at Halpern Financial in Ashburn, Virginia. If you carry a balance on multiple credit cards, start with the one that has the highest interest rate and work your way down from there. That way you’re wiping out your most expensive debt first.

However, financial advisors caution, you also want to do what you can to avoid carrying a credit card balance in the future. If you don’t have an emergency fund, squirrel away the remainder of your bonus (if there is one) or whatever you’re able to manage each month going forward. Ideally, you should have three to six months of living expenses stowed away.

Consider putting the money into a Roth IRA – you’ll pay taxes now, rather than later, but can take back your contributions without penalty in a pinch. If you leave it untouched, the money will be there for retirement. Apps like Qapital, Digit and Acorns (all of which have appeared on the Forbes Fintech 50 list) also help you put away money for later by siphoning off small amounts of your money into savings or investments automatically.

"With no emergency fund, you are one crisis away from getting right back into credit card debt," says Michael Baughman, an advisor at Tryon, North Carolina-based ParsecFinancial. You don’t want to wind up with the same dilemma – credit card debt and little to no savings -- a year from now. A savings buffer can help offset unforeseen expenses, like car repairs or a doctor’s bill, that might have otherwise gone on your plastic.

A possible exception to all this: If you have a new credit card with a special 0% interest rate for the first 12 months, let’s say, you could consider stashing your bonus into a savings account instead. Just be careful and stay on top of your monthly payments. If you have a balance after the introductory period is over, you’ll pay interest on it. (Also watch out for credit cards, usually from retailers, that charge deferred interest. You’ll be on the hook for interest that’s accrued since day one if you don’t pay off your balance before the promotional period ends.)

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