My wife and I recently received our stimulus check. For anyone who doesn’t already know, the amount this time is $1,400 for an individual earning up to $75,000 and $2,800 for a married couple earning up to $150,000. You also get $1,400 for each dependent. This was the largest of the stimulus payments we have received, and it got me thinking about what we should do with the extra money. While everyone’s situation is different (and I’m not a financial advisor in any way), there are generally a few different ways that you should use your stimulus payment based on your current finances. Here I’ve laid out a list in order of priority depending on your situation. (Note that this list applies whenever you get a sudden influx of cash.)
1. Pay off bills
If you are living paycheck-to-paycheck and need the stimulus money to pay your bills, then this is exactly what you should use it for. The objective of the stimulus payments was to help people who need the money and to stimulate the economy to improve economic growth and recovery. If you have been temporarily laid off or your hours or pay have been reduced, then you should use this money to cover any bills or payments you would otherwise be unable to pay. Don’t use the money for a big, fun purchase when you need it simply to survive and keep a roof over your head, however tempting it may be to blow the money on something more exciting.
2. Build up an emergency fund
If you are able to pay your bills without needing to use your stimulus payment, then your next step should be to build up an emergency fund. This is a pool of money meant to be saved up in case of a sudden, unexpected expense like a medical emergency or an unanticipated car repair. Most experts recommend that you save three to six months worth of typical expenses, but depending on your circumstances, you may want to save enough for a whole year. If you don’t know your typical monthly expenses, check out our article on budgeting. Your emergency fund should be kept as liquid as possible, meaning that you can access the cash whenever you need it. Generally this means keeping the money in a savings account. Never invest your emergency fund, as this reduces its liquidity and means that it could potentially lose value. The point of an emergency fund is to be stable and available to support you if and when you need it.
3. Pay off high-interest debts
Once you have saved up an emergency fund, your next priority should be to pay down any high-interest debt, in particular, credit card debt. You want to start with the debt with the highest interest rate and then work your way down. This means that you’ll be able to quickly cut down your largest interest payments, which should give you some relief. Some people might prioritize this step over building up an emergency fund, but I’d argue that it’s more important to have savings to fall back on than to immediately attempt to tackle your debt. This is because if you were to face a sudden expense, you would be able to handle it with your emergency fund rather than falling back into debt. Paying off debt and then having to take on more debt can be a vicious cycle that is best avoided.
4. Contribute to retirement/tax-advantaged investment accounts
If you have already built up an emergency fund and paid off any high-interest debt, your next priority should be funding a retirement or other tax-advantaged investment account. This can include a retirement account like a 401(k) or IRA, a college savings plan like a 529, or a Health Savings Account (HSA). These generally have contribution limits but allow you to avoid paying taxes either now or in the future. Once you have funded your account, you will be able to invest in stocks, bonds, mutual funds, ETFs, or even possibly cryptocurrencies, and your gains will accrue tax-free. Keep in mind, though, that there are usually restrictions on withdrawing your money from the account. You must generally either wait until a specific age (retirement account) or use the money for a specific purpose (529, HSA). Otherwise you will incur penalties and/or taxes.
5. Contribute to general-purpose brokerage accounts
Once you have hit your contribution limit for your tax-advantaged accounts, then consider investing your stimulus payment in a general-purpose brokerage account. You will have to pay taxes on capital gains, but you should be able to grow your money at a much higher rate than in a savings account. There are usually fewer restrictions for a general-purpose investment account than for a tax-advantaged account.
6. Treat yourself
If your finances are already in great condition and you are saving a good portion of your income in tax-advantaged and general-purpose accounts, then feel free to use your stimulus money to treat yourself. There’s no sense in saving all your money for some potentially glorious future at the cost of your current happiness. Buy something you’ve always wanted, go out for a nice dinner, or plan a trip for when the pandemic is over. Saving is important, but if you’re on the right track, it’s okay to have some fun now too.