Whether your income is on the rise or you receive a windfall of unexpected cash, having extra money in your budget is always good news. The best thing to do with it depends on your financial situation, but paying off high-interest debt usually takes priority. You can also use extra cash to build your emergency fund, save for retirement, invest or contribute to other savings goals.
1. Pay Down Your Debts
Carrying debt can get expensive, especially if you have high-interest balances. The average credit card annual percentage rate (APR) is over 21%, according to the November 2023 numbers from the Federal Reserve. The faster you pay off these balances, the more money you'll save. Let's say you owe $2,000 on a credit card with a 20% interest rate and a $55 monthly payment. If you only pay the minimum, it'll take about five years to pay it off—and you'll pay $1,200 in interest.
Below are two popular debt payoff strategies:
- Debt avalanche: This method prioritizes whatever balance has the highest interest rate. Once that's paid off, you take the money you were putting toward that balance and roll it into the next one.
- Debt snowball: This uses the same approach but prioritizes the account with the lowest balance. You might pay more interest overall with the snowball method, but quick wins along the way can help keep you motivated.
Paying down debt is important because it can help improve your credit score. When taken together, your payment history and amounts owed make up about 65% of your FICO® Score☉ . A strong credit score can make it easier to qualify for better loans and credit cards in the future, potentially reducing the amount of interest you'll pay over time.
2. Build Your Emergency Fund
A common rule of thumb is to have three to six months' worth of expenses on hand for emergencies. That can include everything from a surprise bill to a stretch of unemployment. If you've got extra money in your budget, it could help you build your emergency fund—and protect your financial well-being if the unexpected happens.
A high-yield savings account or money market account can be great places to keep your emergency fund. Annual percentage yields (APYs) are generally much higher than traditional savings accounts. You'll also have easy access to your money if you need it.
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3. Grow Your Retirement Fund or Invest
Saving for retirement is always important—the longer your money is invested, the more time you'll have to benefit from compound interest. Here are some ways to use extra money to strengthen your retirement savings. Just keep in mind that these tax-advantaged accounts have annual contribution limits:
- Increase your 401(k) contributions: If you have a 401(k) through work, you probably make contributions through automatic payroll deductions. You can contact your employer to bump up that amount. Try to put in at least enough to secure an employee match.
- Contribute to an IRA: An individual retirement account (IRA) can be a powerful tool for those who don't have access to a 401(k). They can also be used on top of a 401(k) to supercharge your savings. You can open an IRA through a brokerage firm, bank, credit union or mutual fund provider.
- Use a health savings account (HSA): An HSA allows you to set aside pretax dollars that can be used to pay for qualified medical expenses. Once you turn 65, you can use this money as taxable retirement income. HSAs are available to those enrolled in high-deductible health plans.
You can also funnel extra money toward other investments. That may involve opening a brokerage account and trading stocks, bonds, mutual funds, exchange-traded funds (ETFs) and other securities. You might also explore real estate investing, cryptocurrency or other alternative investments.
4. Contribute to Your Savings Goals
Chances are you have other financial goals. That may include:
- Saving a down payment for a home or car
- Funding your next vacation
- Starting a business
- Setting money aside for your kids' college education
- Renovating your house
If you have extra money available, you might go all in on one savings goal—or spread your money out across different goals. Either way, consider keeping short-term savings in a certificate of deposit (CD). They typically offer better yields than other deposit accounts, though liquidity may be an issue. If you plan on using your money in the near future, a money market account or high-yield savings account might be a better option.
The Bottom Line
Having extra money in the bank is certainly a good thing. The question comes down to figuring out what to do with it. Paying down debt, building your emergency fund and saving for retirement should be top of mind. Beyond that, extra cash could go toward other financial goals. What's right for you will depend on your personal financial situation.
Strengthening your financial life is good for your credit too, especially if you're paying your bills on time and keeping your debt balances low. Free credit monitoring with Experian is a simple way to stay up to date with what's on your credit report.
