In January and February many firms, especially banks, give out annual bonuses to employees, which in some cases make up a large percentage of the employee’s annual earnings. After years like 2017, when the economy and global stock markets have done exceptionally well, I am naturally asked, more than in most years, about how to invest a bonus. This time last year I shared my personal story on how I invested my first 10 years of bonuses and 401(k) contributions, and here I share a somewhat more concise how-to.
While I certainly believe it is human to want to spend or donate part of it, there are a few other checklist items I like to check off before diving into the details of how to invest a bonus:
- Have all high-interest debts (especially non-mortgage debts) been paid off?
- Have the amounts for things paid annually (e.g. life insurance, property insurance, and international medical insurance premiums) been set aside?
- Does it make sense to use a chunk of this bonus to pay down the mortgage?
After taking care of these pre-investment questions, I then ask what is the best way to structure a lump sum bonus investment. If you are a US taxpayer, you may first want to fully fund your 401(k) or SEP IRA for the year, especially since the SEP IRA limit has been raised to US$55,000 in 2018. Investors who like physical property may instead look at how a bonus can fund a new property. Otherwise, I find the most flexible way to invest a bonus is in a simple individual brokerage account, but that is of course because I am very familiar with these.
The two extreme mistakes I see with bonus investments are: 1/ keeping it all in cash, so that it doesn’t grow and has its value eroded vs rising prices, or 2/ investing it too aggressively in a concentrated bet. Simply buying a low-cost index fund is a good solution for most, but I prefer to individually own a portfolio of profitable companies rather than a broad index of companies that includes many less profitable ones. Unless the bonus is a large percentage of your overall wealth or lifetime earnings, taking a moderate amount of risk owning profitable businesses strikes a good balance between safety and growth.
Contact me through the form below if you’d like to discuss how to put together such a portfolio.