What To Do With Extra Money

Receiving an unexpected windfall or simply having some extra cash in your account after doing the monthly budget can be a pleasant surprise. However, what's the best way to use that extra cash?

Although you may be tempted to splurge on an impromptu vacation or just a night out on the town, there are far more practical uses for that extra money. Using extra cash wisely may help improve your financial situation or even help in reaching a monetary goal sooner than expected.

In this article on what to do with extra money, we'll cover some of the ways you may be able to put that unexpected cash to good use.

First Things First: Assess Your Financial Situation

Before you decide what to do with that extra cash, consider where it could be best used. 

You may wish to discuss the matter with a professional financial planner who should consider your unique financial situation and make a recommendation.

However, it may also be helpful to examine your accounts yourself to get an idea of where a cash infusion may be needed most.

For example, if you have high-interest credit card bills with revolving balances, it may be best to prioritize paying them down. By paying the balances down, you may be able to save some considerable cash that would otherwise have been lost to interest payments.

On the other hand, if you have no debt but also don't have any savings, a good priority may be to establish an emergency fund — ideally in an interest-paying account.

You might also want to use the money to invest in yourself and take educational courses that increase your skillset and ultimately help your future career prospects.

Once you've decided the best option for your personal financial situation, it's time to put that cash to good use. Here are some of the most potentially beneficial ways to use extra money. 

Build an Emergency Fund

Having an emergency fund may make all the difference when facing an unexpected financial crisis.

What Is an Emergency Fund?

An emergency fund is money saved in a bank account to use for unexpected expenses. This expense could be anything from needing a new set of tires to paying an expensive medical bill to covering several months' worth of living expenses were you to lose your job.

By building an emergency fund, an unexpected expense might not need to be funded with high-interest credit cards or personal loans. You also may not have to dip into a retirement fund, depleting your 401(k), and losing money to early-withdrawal penalty fees. 

How Much Money Do You Need in an Emergency Fund?

There's no one-size-fits-all answer to the question of how much money you should keep in an emergency fund. The solution that best suits your needs depends on personal income and monthly expenses. Many financial planners recommend saving at least three months' worth of living expenses in your emergency fund. That's because, for many, their worst-case financial scenario would be the loss of a job. Three months of savings may give you enough time to find a new position while paying bills and buying life's essentials. 

However, you may want to save even more if you are a freelancer, part-time worker, or anyone else with a fluctuating income. And if you have debt in the form of car payments or credit card bills, you may want to save just a month's worth of expenses before prioritizing debt reduction.

Where Should I Keep My Emergency Fund?

Traditional savings accounts are among the most popular options for emergency funds. That's due to their interest-earning potential and the ease of withdrawing money in a pinch. Many banks allow traditional savings account holders to make up to six withdrawals per month without fees.

Although you can save money in a checking account, it may not earn any interest. At the same time, if you keep your savings in a checking account, there’s always the possibility it gets accidentally spent. 

Likewise, if you store an entire emergency fund in a certificate of deposit (CD), it's possible to incur a penalty if the funds are withdrawn before the maturity date. 

A high-yield savings account is also a particularly appealing home for an emergency fund. This account may pay significantly higher interest rates than regular savings accounts. However, you may have to pay a fee if the account balance dips below a certain minimum.

Pay Down Debt

Many financial experts say that eliminating debt is one of the most important financial steps you can take. However, not all debt is created equal. There are both good and bad debts. Here's a quick breakdown:

• Good debt: Helps grow your wealth or income and tends to have a relatively lower interest rate. Examples include mortgages, car loans, and student loans.
• Bad debt: Makes your financial situation worse via high or variable interest rates. Examples include credit cards and high-interest personal loans (when used for nonessential purchases).

If you have bad debt, it is advisable to prioritize paying it off as quickly as possible. On the other hand, you may not be in a rush to pay off good debt and want to prioritize other uses for the extra cash.

Strategies for Paying off Debt

There are myriad strategies for paying off a credit card or other form of debt. They include popular methods such as the:

• Debt avalanche: Plunge your money into the debts with the highest interest rates first.
• Debt snowball: Prioritize paying off debt in order from smallest to largest balance.

Which strategy is right for you depends on your unique situation. However, no matter the chosen strategy, it's important to stick to your debt-reduction goal until it is accomplished.

Increase Your Savings

If you've already saved up an emergency fund and don't have any high-interest debt balances to pay off, you may want to use the extra cash to boost a savings account or open a new one.

Types of Savings Accounts

Here's a quick rundown on the most popular types of savings accounts:

• Traditional savings accounts: These accounts may be found at most banks and allow account holders to earn a small amount of interest. Savings accounts offer easy access to funds, offering up to six fee-free withdrawals per month.
• High-yield savings accounts: These accounts typically offer higher interest payouts than traditional savings accounts. However, you may incur a fee if the account balance falls below a specified minimum. In addition, not all banks may offer high-yield savings accounts in all markets.
• Money market accounts (MMAs): These accounts are similar to traditional savings accounts but may offer higher interest payout rates. MMAs may also offer some of the features of checking accounts, such as access to automated teller machines (ATMs) and the ability to write checks.
• Certificates of deposit: These products typically offer higher interest rates than traditional savings accounts. However, with many CDs, you must commit the funds to the account until the maturity date in return for the higher interest. These terms may last between few weeks to several years. If an early withdrawal is made, you may face a penalty, such as forfeiting any earned interest.

Increase Your Retirement Contributions

If you've received some extra cash, consider contributing it to retirement savings accounts. You may do this by increasing contributions to a 401(k) or 403(b) — especially if your employer will match contributions. This may give your retirement account a significant boost.

Alternatively, you could use the extra money to open an individual retirement account (IRA). These investment accounts offer tax advantages. For example, contributions to traditional IRAs are usually tax-deductible. On the other hand, Roth IRAs allow investors to enjoy tax-free qualified distributions once they've reached retirement age.

If your retirement contributions are already maxed out, consider contributing the extra funds to a taxable investing account.

Invest in Yourself

Investing in yourself may be one of the most rewarding investments on this list. Doing so may improve your career or financial situation by following one of these example goals:

• Earn a degree to increase your earning potential (or pursue a lifelong dream).
• Study for a professional certificate that will boost your chance of a promotion or higher salary.
• Start your own business without taking on business loans.
• Learn a new skill that may make you more professionally in demand or help you earn more income.
• Save for your child's future in a custodial or education-focused savings account.

The Bottom Line

Having excess cash can be a pleasant surprise, but determining what to do with extra money may be a challenge. If you don't have a clear money goal, it may be a wise idea to put the extra cash in an interest-paying savings account while you consider the options. This way, your funds will be safe and may even grow.