When I got the first job that paid more money than I actually needed each month, I wasn’t sure what exactly I should do with it. Sure, I had plenty of ideas. But what was the best thing? What would help me make my money work for me instead of just working for my money? These questions put me into research mode and led me into a personal finance journey that I still haven’t gotten tired of. There is lots to learn about personal finance. But at the end of the day, what you should do with any extra income is pretty straightforward. If you’re wondering what you should do with extra money coming your way, I’ve gleaned some solid advice that I’d love to share you.
First of all, it’s really important to decide ahead of time what you’ll do with extra money. If you don’t pre-decide, I promise you that the pretty new sweater from Nordstrom or the perfect addition to your collection from Amazon will really feel like a need (#preachingtomyself). Here are a few great options for extra income based on where you’re at with your finances right now.
If you’re living paycheck to paycheck
The first step you should take on your financial journey is to start an emergency fund. Most experts recommend building it up to $1,000 before focusing on paying off your debts. The reasons to have at least a little bit of an emergency fund are many. It will prevent you from going further into debt if the unforeseeable happens, such as if your car breaks down or you have to take your dog to the vet. It also contributes to your mental health. If you know you have at least a little bit of a cushion, you’ll have less anxiety when it comes to thinking about your finances.
While only $1,000 in your emergency fund (while you’re paying off debt) is recommended, there are a few reasons you may want a bigger fund. If you’re driving a car that frequently needs repairs or has a lot of miles on it, you could easily exceed your $1,000 fund. It’s also helpful to have more of an emergency fund if you have health problems and think you might have medical bills in the near future. Being self-employed is another great reason to have a greater emergency fund since that extra income might fluctuate. There’s no one best amount for everyone, so take an honest look at your financial needs and assess what will work best for you.
Decide ahead of time what your goal is and track your progress as you work towards it. I love to track my financial goals in Mint, which is a great free tool to use. The goals feature is only available on the website right now, so if you’re looking for it in the app, you won’t be able to find it. There are lots of other ways to track your financial goals. Some of my favorites are what people do in their bullet journals or the coloring pages they create.
If you already have a little cushion
Pay off your debt
Once you have an emergency fund, the very next thing you should start working on is paying off your debt. We live in a society that tells us that there is such a thing as good debt and bad debt. But unless you have 0% interest for life, all types of debt are costing you money every month and quite a lot in the long run. Let’s say you have a car loan for $8,000 with only 4.5% interest. That’s not too bad, right? For a 5 year loan, your payments will be $149 a month and you’ll pay $948 in interest. Look at what happens if you decide to pay extra each month.
If you double your monthly payment, you’ll pay off the loan 2.5 years early! But on top of this, you’ll be able to invest almost as much as the initial price of the loan. By paying an extra $150 a month, you end up with $8k in your investment account in 5 years. Now imagine that you didn’t pay any extra at all? In the same amount of time it took you to get $8k, you’ll have $0. That’s just an example of one small interest loan. If you work on paying off all your loans, you could be saving a lot of money. I love to use this calculator to play around with how much I can save by coming up with extra payments. This is a great calculator to show you how much you can gain by investing.
Debt Payoff Methods
Now that I’ve convinced you how powerful it is to pay off loans early, you might be wondering which one you should start with. There are two different methods that you can use. It’s really important to know yourself when deciding which debt to pay off first. If money is really stressful for you, you feel like you could lose the motivation to pay off debt at any moment, or you’re so discouraged that you could use a couple small wins, then you should pay off debt using the snowball method.
The snowball method involves paying off the debt that has the smallest monthly payment first while paying the minimum on all other debts. Maybe you have a store credit card that you used to purchase a professional wardrobe for that new job (and extra income) that you have. Paying off the few hundred on that and being done with it might just be the win you need before you start really focusing on paying off your student loans. Put all your extra income toward the smallest debt first. Then, as soon as it’s paid, put the monthly payment you would have put toward the smallest debt to the next smallest debt until that gets paid off. As you keep doing this, your monthly payments toward your next debt keeps snowballing, until eventually you just have one debt left and you’re putting a big chunk of money towards it every month.
If you’re highly motivated to pay off your debt and know that there’s not a lot that can get you off track, the avalanche method is probably right for you. In this method, you’ll put your extra income towards the debt with the highest interest first. This is usually any credit card debt you might have, but you’ll want to get a list of all your debts and interest rates just to be sure.
The benefit to this method is that you end up paying the least amount of money in the end. High interest rates cause your debt to multiply over time. By paying off the ones with the highest interest first, you prevent this from happening. It’s not uncommon for your highest interest rate debt to be your biggest monthly payment, so this can be discouraging when you first start really focusing on paying off debt. This method definitely has the biggest payoff though, so if you know you can stay focused, this will be a great option for you.
There’s no wrong answer to which method you choose. Both of them work. The important thing is to understand what will work better for you. Once you figure that out, you can keep at it until you’re debt free.
If you have a small emergency fund and little to no debt
First of all, congratulations! This is an awesome place to be. Not a lot of people find themselves in this position. It might be tempting to spend most of what you earn, but there are still some better things to do with that extra income to set you up for financial success.
Build up your emergency fund
Once you’ve paid off debt, make sure that you build up your emergency fund to 3-6 months of living expenses. This will protect you for larger emergencies (like if your house burns down or you lose your job). Another reason a healthy emergency fund can be of huge benefit to you is that it grants you freedom. Hate your job? You can quit, knowing you have 3-6 months before finding another. I love that kind of freedom!
Emergency funds should always be kept somewhere safe (ie not under your mattress) but where you can access the money fairly quickly (because it’s not really an emergency if you know about it ahead of time). But should you save 3 or 6 months worth of funds? This depends on your situation. If you have a very secure job and are not likely to get fired or laid off soon, then 3 months should be plenty. If your job is less secure, seasonal, or you’re self-employed, then 6 months is certainly a safer option.
Save for Retirement
To be perfectly honest, saving for retirement sounds like the least fun thing to do with your money. There are so many things in the much nearer future that you can save for. But the earlier you get started, the better the results. That’s not really because you’re putting more money in. It’s the power of compounding interest. This is a great article explaining just how much more you can save if you start in your 20s versus starting in your 30s. Just a little bit of money saved 10 years earlier makes a huge difference.
But what if you don’t have extra income?
Maybe you’re already putting all of your income towards living expenses and don’t have any leftover. This is a sticky situation to be in, and I promise you you’re not alone. The first thing you should do is keep track of your spending to make sure that all of it is necessary. If it’s still looking like you’ll have to spend more each month than what you can earn, your next best option is to find a way to earn more. Every little bit helps, so even if you don’t have a whole lot of time, it’s worth it to look into a side hustle. Also remember that extra income doesn’t have to be just from your paycheck. Here are some other forms of extra income to be mindful of:
- Tax return
- Year-end bonuses
- Raise at work
- Clearing clutter and selling it for a profit
A Final Note
I already mentioned this earlier, but clear goals are really essential when it comes to managing your money. If you don’t know exactly what your highest priority is, you’ll spend half of your money and save the rest in random places. This makes it so that you’re not making a lot of progress in any one area. Think about what financial goal will make the biggest difference in your life over the long term and go for those.
Know your why. Even if you have a clear goal, it’s no fun going after it unless you really know why it’s important. It’s important to know not just that you want an emergency fund, but what it will mean for your life. Will it give you peace of mind? Can it keep you from spiraling into debt, meaning that you can pay for your kids’ college when the time comes? Will it be the first step on the road to opening up your own business someday? Those are much more meaningful goals which will help you stay focused on getting your finances in order.
Have an optimistic mindset. It can be discouraging when you feel like you have a ton of debt that will take years to pay off. You might want to quit when you realize that at your current savings rate it will take you 2+ years to finish your emergency fund. Don’t let that discourage you! The habits you’re building and knowledge you’re gaining will continue to serve you for the rest of your life. Small changes can make a huge difference. If you keep at it, you’ll get there someday.
Leave a comment and let me know what your biggest financial goals are right now. My husband and I are still building up our emergency fund. It feels like it’s taking forever, but I know we’ll get there! How about you?