There’s plenty of advice out there on the Internet for what to do with a windfall gain, but that’s only good for people who actually have a secretly wealthy long-lost relative, or who play the lottery and actually win. Very few of us will randomly and unexpectedly get a check for tens of thousands of dollars — life is just unfair like that. But many of us do freelance work in addition to what we do at our day jobs, and this can mean big, meaty checks in our mailboxes, but nothing you could rightfully call a windfall. A check for $4,000 here or $2,000 there is certainly not enough to fundamentally change your life for the better, but that’s no reason to not treat it with the gravity it deserves. We’re talking about earned income here, not a windfall.
So, what should you do with a check that you have a.) earned and b.) is larger than, and earned on top of, your normal monthly income. Perhaps this is a rare occurrence. Perhaps it is not. It has happened to me twice this year, and I doubt I’m on my own. It’s hard to categorize because it is both income and a windfall. I suspect this has something to Milton Friedman’s permanent income hypothesis, which states that people’s spending habits are changed less by temporary income changes than permanent income changes. If you get a $5,000 a year raise, you’ll spend a bit more a month; if you get a check for $5,000, you won’t prorate that over the course of a year in similar fashion.
If Friedman is right — he’s not someone we typically agree with around here — that puts me at an advantage compared to those who earn $5,000 more than I do a year, at least as far as savings is concerned. Someone who earns $30,000 a year on salary has $400 more to spend a month than someone who earns $25,000, but someone who earns $25,000 and gets a $5,000 check once over the course of a year will probably put more away, because they are so accustomed to their poverty. This is good news for broke people — counter to all logic, you’re more likely to save.
(Of course, this is from one of the forefathers of supply-side economics, so there might very well be a neoliberal, quasi-political bent to what Friedman is saying: basically that giving money to people will not increase their spending; i.e., direct stimulus will not positively impact the economy in the way a Keynesian economist would argue.)
With all these caveats in mind, here is what we recommend you do with a check like this.
1. Put Aside at Least One Quarter for Taxes: A third if you want to play it safe, but putting aside or pre-paying at least 25 percent should help soften the blow come April. Complain about your W-4 withholdings all you want, there’s nothing more painful than signing away thousands of dollars you’ve come to feel like you own to the Armed Forces, Medicare and Social Security at the end of the year. Acknowledge upfront that a substantial portion of this money is not yours to keep, and you’ll be able to budget better over the course of the year. There’s no reason to be in financial limbo between January and April of every year because you haven’t set your taxes aside.
2. Do Something Nice for Yourself (That Costs Less than 15% of Gross): That’s right, pal, you earned this money. You deserve to treat yourself to something nice every once in a while, otherwise all that extra work might not seem worthwhile. With windfall gains, planners recommend you spend no more than 5 percent of gross, but that’s boring and unfair advice for us to give here. Out of a big freelance check, that might be just a couple hundred dollars. So we upped the cap to 15 percent. Go nuts, but think like Milton Friedman when you do this. Don’t go out and get yourself a $2,000 suit just because you have a few thousand extra dollars on hand. Instead, take you and your significant other, or a good friend, out for a fancy dinner you might not otherwise be willing to pay for. There’s an important distinction between buying something you could not normally afford and buying something you were previously unwilling to pay for. A $250 dinner wouldn’t bankrupt you normally, sure, but it likely isn’t something you’d spring for outside of a special occasion — now you have one.
This, we can say with no hesitation, is probably the most important tip we have. Money is more than just a chore. You can turn money into a night at a nice hotel, or a plane ticket, or a steak dinner — whatever it is you want that’s just been out of reach.
3. Pay Down Debt: Prevailing interest rates on CDs and MMAs and any other savings vehicle are pathetic right now. According to MyBankTracker numbers the national average for a 12 month CD is 0.53% — inflation beats that by a long shot. Your credit card or student loans, on the other hand, likely boasts an interest rate several times that. It’s never fun to hear it, but here it is again: despite your natural aversion to doing so, you actually are saving money by paying down debts now instead of later. We know you hate hearing this, but it’s just so true.
4. Save, Save, Save (and Maybe Invest): Put the rest into savings where you might be less likely to touch it, but free to touch it when you need (or want) to. Like Milton Friedman suggested you would, you’re going to stick to your normal budget, big check or not. The best thing you can do with your money is save it for when you really need it. Keep some of it totally liquid, in a savings account, and seek out better rates with less liquid investments like CDs or mutual funds.
You might owe a little extra to taxes, after all.