Bonus payout time is the most highly awaited time of the year. But it is what we do when the cash hits our accounts that matters. With CNY around the corner, you could spend your bonus payout — indulge in a much-deserved vacation, treat ourselves to some retail therapy, or you might even use it to fund what you want to distribute in Chinese New Year red packets. Of course, a more financially responsible decision would be to save our bonus payout for a rainy day – small returns but lower risks. The alternative is to invest our bonus so it can grow and reward us further down the road — higher risk, but higher returns. Those are the options, spend, save or invest — it’s an age-old dilemma that usually requires you to choose one, and forego the others. Or is it? At LU Global we think you can have your cake and eat it too. Here are five checklist items to ask when evaluating what to do with your annual bonus payout. Answering these questions will also help you start the new Chinese lunar year right by putting you on the path toward tackling as many of your financial resolutions as possible.
1: Do I Have Good Debt or Bad Debt (and what interest rates am I paying)?
Not all debt is created equal: there is both ‘good’ debt and ‘bad’ debt. An easy way to tell them apart is by looking at what the debt is being used to finance. If you’ve taken on debt to finance an asset, such as property, then it’s generally regarded as ‘good’ debt. ‘Bad’ debt is usually debt which is taken on to finance lifestyle expenses — it could be fancy furniture, clothes or lavish vacations. ‘Bad’ debt is also typically financed via credit cards, cash advances, or personal loans—all of which carry very high-interest rates. Don’t be fooled by the seemingly low monthly rates you see advertised. A 2% monthly interest rate on your credit card balance is equivalent to a 24% annual interest rate! The average annual interest rates of credit cards and cash advances in Singapore is 25% and 26.7%, respectively.
So, if you have any ‘bad’ debt, the most prudent choice might be to use your bonus payout money to pay down as much of it as possible before considering investing.
But what about ‘good’ debt? Is it best to also pay it down immediately? The answer is more complex because you should also compare interest rates on the debt with the potential returns if that money were to be invested. For instance, if you have a mortgage with a 3% interest rate and an investment opportunity that is expected to return 6% per annum, it might make better financial sense to channel money into that investment and keep your mortgage instead of trying to pay it off early.
“For ‘good’ debt always consider the opportunity cost—what excess returns over the cost of debt would you get if you were to invest the money instead of saving it?”
#2: How much emergency savings do I have?
They say if you fall, it’s better to land on a cushion than on concrete. That’s the role that an emergency savings fund plays in your financial life. Whether it is a sudden job loss, medical bills, or urgent home repairs, you need to give yourself a cushion of funds against the unexpected. Not having emergency savings can lead to spiralling consequences, such as being forced to take on ‘bad’ debt.
There is no set amount you should keep in your emergency savings, and again, it depends on your risk tolerance. In general, 3 to 6 months of living expenses is usually recommended, particularly to protect against the risk of temporary unemployment. If you are more conservative, you might want to increase that to a year.
So, if your financial cushion is looking a little deflated, your annual bonus money might best be used to pump it up. Remember, when funding your emergency savings, the keyword to keep in mind is liquidity — your funds must be readily accessible.
#3: What are my short, medium, and long-term financial goals?
If you have no ‘bad’ debt, and already have a solid cushion of emergency savings, the next thing to consider when deciding between saving or investing your bonus payout is your financial goals. Without financial goals, you’ll be like a rudderless ship — no matter how powerful the engine, it will just mill about the ocean with no clear destination.
Divide your financial goals broadly into short-term, medium-term, and long-term goals. For example, a short-term financial goal could be having one year of living expenses in emergency savings, a medium-term financial goal could be financing your children’s higher education, and a long-term financial goal could be funding a comfortable retirement.
Now, determine which goal is your highest priority. Then, see which one would be best served by either saving or investing your annual bonus payout. For instance, your top priority may be saving for a property down payment within the next couple of years so the question is – is it better to save or invest to hit that goal? In general, short-term goals tend toward saving, while longer-term goals tend toward investing. This is because investing is usually not very liquid, requiring lengthy lock-up periods, which makes them less appropriate for shorter-term goals. On the flip side, however, the lower returns from savings can make shorter-term targets harder to achieve. LU Global’s investment app sets out to overcome this constraint. Our lock-up periods for our fixed term investment products start as low as 3 months, and many of our longer-term investment products also have early redemption options, making them suitable to help achieve both shorter-term and longer-term goals. On top of that, our investment app charges $0 subscription fees for all fixed term products while some of our flexible term products which are traded daily, charge a flat fixed fee of US$25 per trade transaction (versus up to 3 – 5% market rates elsewhere). There’s also additional flexibility through our new secondary market, MarketPlace, which allows the LU Global investor community to buy and sell their existing portfolio holdings before maturity, for various liquidity-driven situations.
#4: What is my risk tolerance?
If financial goals are one side of the coin, risk tolerance is the other. How much risk are you willing to take in pursuit of your goals? This depends not only on individual circumstances but also on personality traits. Risk tolerance, like financial goals, is something deeply personal.
Some investors may feel more comfortable with a higher savings allocation with a lower risk profile and are willing to forgo greater returns. Others may be willing to take on more risk, with a higher investment allocation, for a higher potential return. Ultimately, there’s no right or wrong answer, but your risk tolerance will no doubt play a large role in whether you prefer to save or invest your bonus payout.
That said, you should also bear in mind how the time horizon affects risk tolerance. The greater the time horizon, the less short-term volatility matters. So, even for the more risk-averse, it still makes sense to be biased toward investments for longer-term goals and prioritise savings for shorter-term ones. On LU Global’s investment app, we offer a range of renowned investment products that cater to a variety of risk tolerance levels. New users are also required to complete a risk assessment prior to investing, which allows us to gauge risk appetite levels and suggest investment products that belong to your risk tolerance level.
#5: What brings me happiness, contentment, and meaning?
Money may indeed make the world go round, but it isn’t everything. At the end of the day, money cannot be an end in itself, it can only be a means to an end. Family, friends, our own mental health and wellbeing, giving back to society — these are the things that truly matter. So, if you’re a savvy investor who has already internalised timeless investment lessons, there’s no need to hesitate about spending your annual bonus payout on the things that matter most to you. Whether it’s donating to a charitable cause, helping a family member in need, or just going on a trip to rejuvenate your mental health, you can and should do so guilt-free. LU Global gives you the freedom and flexibility to invest for any goal. At LU Global, we believe in giving the control back to the investor. Our investment app allows you to invest in both short-term and long-term goals. So, when you’re looking at ways to invest your annual bonus payout, join over 370,000 registered LU Global users and download our investment app to navigate the modern investing landscape and make your way towards realising those new year resolutions and Chinese New Year goals.