End of year bonus: How much should you save or spend? - Limerick financial planner

IT'S that time of year again, when year-end bonuses have been or are about to be announced. And it’s an area I’ve covered for you before but I am getting lots of requests from readers in the past couple of weeks asking me to write about it again.
So here goes.
Before any bonus lands in your account, it’s important to put some thought into what you should do with some of it and how you can optimise it, because after all it was hard earned and you want to make best use of it.
I say some of it, because maybe you’re not planning on spending all of it and maybe you’re not going to save it all either, so you might be wondering is there an optimum amount or percentage you should split between both?
And I think there is.

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I referred to a rule of thumb in an article I posted a couple of weeks back about the percentage you should save and/or spend when you receive a salary increase. And they’re excellent numbers which also can be applied to a yearly bonus payment.
Let me remind you what they are.
1. spend twice your years to retirement
2. save your age, as a % of the bonus
If your bonus happened to be €4,000 and you were 32, then the rule of thumbs would suggest you spend 66% of your bonus i.e. 32-65=33 x 2 = 66.
So, you are free to spend €2,640 of your bonus and save the balance.
When we look at the second rule of thumb, it would suggest this same person save 32% of their bonus and spend the rest, so both rules of thumb come out about the same.
Which is spend two-thirds of your bonus and save one-third.
Having said that, if you are carrying high, double-digit debt, or you’re saving for a deposit on a house or something else, or you have very little in savings, then perhaps these percentages need to be adjusted and skewed more towards saving and or paying off debt, and a much less percentage being apportioned to spending.
Okay, let’s assume you’re good with the percentage and you now know the amount you can spend, what are you going to do about the savings portion? Where are you going to lodge those monies, and I see five good areas:

Get rid of debt
As I said already, but I’ll say it again, depending on your circumstances, paying off debt is something you may have to do. But if you feel aggrieved that you have to, it may help knowing that paying down or off entirely can be a really good investment as well.
And yes, I absolutely get that it’s not the most glamorous way of spending your bonus but it can be one of your better financial decisions, nonetheless. The less debt you have, the more of your income that can be freed up and applied to other areas. And of course you’ll pay less interest in the long run but that’s nearly a by the way because it’s not something visible that you’ll see lodged to your account, whereas having more disposable income is. And the type of debt I am referring to here is debt like credit or store cards, personal loans, and overdrafts. They are the most expensive debt and they should be tackled first.
If for example, you owe €3,000 on a credit card at a rate of 18% and you pay €50 each month towards it, it will take you 12.9 years before it’s repaid in full and you will have paid €1,733 in interest payments in the process. Put that €3,000 on deposit and after you account for DIRT tax, it would earn just €5 in interest over 12 months.
So, paying off debt, especially when rates for money on deposit are so low and inflation so high, is a great investment.

Increase your retirement fund
You may not be contributing the maximum amount to your retirement fund as you are allowed to and you could top up the amount by making lump sum lodgements to your pension by way of additional voluntary contributions (AVC).
If for example, you are aged 31, you can make personal contributions of 20% of your income up to a maximum income limit of €115,000.
So, if you are currently contributing, let’s say 8% of salary, you can make additional contributions up to 12%. And remember, what you can contribute is separate to what an employer contributes, they are mutually exclusive.
If we look at that example I gave earlier where that person has €1,360 to save, and if they lodge that to their pension fund, after tax relief, and let’s assume they pay tax at the marginal rate of 40%, it will only cost them €816, because they are getting tax relief of €544.
Which means when they receive the tax relief back, they can increase the amount they can spend from their bonus by a further €544. So, out of their bonus of €4,000 their spend can now be €3,184, but they haven’t sacrificed the amount they should have saved, that amount remains the same.
So, along with planning for their future selves, adopting this strategy they are turning their €4,000 bonus into a €4,544 one.
If they pay tax at the standard 20% rate, they’ll get €272 back in tax relief and their bonus turns into €4,272.

Boost your emergency fund
Ideally you want to have somewhere between three and six months of your monthly income in reserve in the event of something unforeseen happening.
And accumulating that amount can be a big ask if you are trying to save towards other things and have a life in the process.
A lump sum is a great way to kick start or accelerate the amount you need to hold in the event of an unexpected happening. So, if you don’t have that emergency fund locked in just yet, consider bumping up your fund from some of your bonus this year.

Invest for long term growth
We know if you leave money on deposit, it will earn nothing. In fact it will go down in value when you factor in inflation.
If that €1,360 I spoke about was saved, next year after inflation takes hold, will be worth just €1,292.
Which isn’t a deal breaker but when you factor in the opportunity lost, of not investing in accounts that earn for example 5%, the differential between money on deposit and in a good managed fund becomes quite wide.
And you might think 5% is quite high and where would you get that type of return. In fact, I’m low balling the return at 5%, we have accounts where our own clients have achieved returns of +23.2% over the past years so an average annual return of 7.73% and that’s in a cautiously managed fund, not a high risk one. So these accounts exist and there are lots of them.
So, the type of fund you invest in is important, it has to be in a good Exchange Traded Fund (ETF) or a managed fund, it just has to be. Or perhaps you can use an on-line exchange traded platform like Etorro or Degiro or Revelot to buy crypto if you wanted to and see how that goes.
Whatever mechanism you choose whether it’s hands on or off you must be proactive and do something. You don’t really have a choice if you want your savings to be on a par with inflation which is currently at about 3%. That’s the minimum return you need to achieve for your savings just to hold their value.
And you ain’t going to get that if it’s sitting in a current or deposit account that’s for sure.

Investment in yourself
A bit of a cliché I know but investing in yourself is something you should consider, because your career is where most people get the vast majority of their income from which is why you need to never stop focusing on it.
Using some of your bonus to invest in further education, books, attending conferences etc. is making good use of it and even a small change to how you work and what you do, can make a big difference. Bringing an extra value to an employer above what’s expected and making yourself more valuable to them and more attractive to others, can increase the amount you earn, which can result in hundreds of thousands of extra income earned over your lifetime.
And there is only so much you can reduce your outgoings by. There is a floor to how much you can spend, but there is no limit to the amount you can earn, none. And that’s why you need to always focus on personal development. You need to widen the gap between your outgoings and income, and that means you need to earn more, and investing in yourself is one sure way you can do that.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie