25 Jan, 2014

It is Diwali time and if Goddess Lakshmi has bestowed her blessings on you, there is a good chance that you are or would be sitting on a hefty Diwali bonus in your bank account. While most of us love to see that money in our bank account, we are often a little lost in terms of what to do with it. With no clear strategy on how that money should be used coupled with retailers wooing you everyday with best deals on just about everything, you may often end up splurging it on things which perhaps you could have done without. This realization may dawn eventually but the damage would already be done.

So how can one use this once a year opportunity to gain on the financial front rather than lose? The common tendency to treat a bonus is to think of it as a windfall gain and hence view it differently from regular income and savings. In behavioral finance, this tendency is called mental accounting where you treat money received from different sources differently. The key point to consider is that money is fungible and regardless of its origins or intended use, all money is the same. So if you have some goals you are working towards, your Diwali bonus can be used to speeden up these goals. For those of you who don't have a clear plan, here are some of things that you can do with your Diwali bonus

1. Pay off high cost debt - It is not uncommon to see people carrying credit card debt and using any surplus to invest, if not spend. If you are paying 30-36% as interest on your credit card and investing in a fixed deposit or other similar investment, which will earn you 8%, are you not better off by paying off your debt rather than investing? Paying off high cost debt should be the top most priority if you receive a lumpsum amount.
Given that interest rates are rising, your home loan too may become costlier in future. If there is no other need for the money, you could plan to clear off a part of your home loan by making a prepayment. This will not only reduce the tenure but also amount to a huge savings in the interest outgo.

2. Save for the rainy day - It is prudent to have at least 4-6 months expenses set aside towards any contingency needs. However, people are often not able to do that through their regular savings because of commitments towards EMIs, insurance premiums, SIPs etc. Or they may take years to build a contingency fund. A lump sum bonus can be used to create a contingency fund where by you would have some cushion in case of any eventuality such as loss of job, medical emergency and the like.

3. Buy insurance which you have been postponing for want of funds - Underinsurance or no insurance for life, health and disability is perhaps the most common folly that individuals commit. Life is unpredictable and one can never be prepared enough for what may be in store tomorrow.  People may postpone the decision to buy insurances because committing large amount of money in one shot does not find favour with most. They would rather get the insurances in place over a couple of years. A bonus payout is a good opportunity to get yourself adequately insured. It is the best gift you can give your family.

4. Meet your tax saving target - This is especially useful for those who need to plan for their Rs 1 lac deduction limit under 80 C of the Income Tax Act. Instead of scrambling for tax saving options at the last minute, you can plan to use a part of your bonus to invest in instruments eligible for 80C deduction. 

5. Allocate money to your long-term goals - You may be planning for certain long term goals such as purchase of house, children education and retirement. Often, due to non-performance of investments, it is possible that you may fall short on the targeted values of these goals. Bonuses may provide an opportunity to get your goals back on track and make good the lack of performance of the investment.

6. Go on a vacation - If you are the kind who has been diligently saving every single penny and has managed to meet your savings target every single time, there is a good chance that the side effect of this could be no discretionary spending such as travel and shopping. Use this money to reward yourself and your family. Family vacations are an excellent opportunity to bond and provide exposure to your children. So if you don't remember when you took that last vacation, given yourself a break and take a vacation, guilt free.

7. Spend if you want, but wisely - A lot of people have a wish list ready before Diwali. It could be shopping for jewellery, purchasing a consumer durable or even shopping for clothes. You may set aside a part of your bonus for some of these wants. However, a note of caution here that although these things may provide temporary pleasure, using money towards any of the above mentioned points would definitely leave you happier and satisfied.

A good way to spend a Diwali bonus may be to balance between things providing immediate gratification and things that are good for your overall financial life. Of course, weightage to the latter should be much higher. By doing this, you would not only enjoy the festival but also be able to pat yourself on the back for using your money efficiently.