Though year-end bonuses are by no means a given, they're becoming a more popular practice across a wide range of industries. According to Challenger, Gray & Christmas, a Chicago-based global outplacement company, almost 80% of employers give out annual bonuses, and while most aren't the epic payouts you hear about coming out of Wall Street, they give their lucky recipients a reason to celebrate nonetheless. Still, while getting a bonus is certainly a good thing, there's a danger in relying on that bonus year after year.
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Don't count your bonus in your budget
There's a reason they call that year-end payout a bonus -- much of the time, it's by no means guaranteed. Though some bonuses are based on individual performance, many are based on company success (if your company does well, you do well). There's also a third category of bonus that's a hybrid of both. While the individual performance model conceivably gives you the greatest control over your financial fate, most bonuses are precarious by nature.
Take the individual performance bonus. You might think you're doing a great job, and you may even have some data to back up that claim. But if another employee outperforms you, you may not get the number you're hoping for. Bonuses that are based heavily on company performance are even more tenuous. All it takes is one bad year or a better competing product on the market to make your bonus go from sizable to virtually non-existent. This is why it's always best to regard your bonus as extra money you weren't counting on in the first place. What this also means is that you shouldn't factor your bonus into your monthly budget, but rather plan your expenses based on your salary alone.
Let's say you've received a $6,000 bonus for the past three years. Going into the following year, you might be tempted to go the optimistic route and pad your budget by $500 a month, thinking you'll receive the equivalent in a lump sum at the end of the year. But what happens if December rolls around, and your bonus winds up being a big, fat nothing? Suddenly, you've overspent throughout the year (or, worse yet, racked up debt) and now have no way to make up for it.
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A better way to use your bonus
If you take your bonus out of the equation when creating your monthly budget at the beginning of the year, you'll be putting yourself in a much safer financial position. Plus, if you don't pre-spend your bonus on living expenses throughout the year, you'll have more opportunities to put your bonus to good use.
Imagine you get a $6,000 bonus, and rather than use it to pay for a more expensive apartment or vehicle, you save and invest it for the future. With a stock-centric portfolio, you stand a good chance at generating an average yearly return of 8%. Leave that $6,000 alone, and after 30 years, you'll have a balance of roughly $60,000.
Another smart way to spend your bonus? Use it to pay off debt, which will save you money in the long run. Let's say you happen to owe $6,000 on a credit card that's charging you 12% interest each year to carry that balance. If it takes you three years to pay off that debt, you'll wind up losing almost $1,200 to interest charges. On the other hand, if you apply that bonus to your outstanding balance and pay it off in one fell swoop, you'll save yourself the $1,200 you otherwise would've wasted.
If you do insist on using your bonus to buy yourself a more comfortable lifestyle in the short term, your best bet is to collect your payout in December, bank it, and withdraw from that balance each month until it runs out. So, if you receive $6,000 at the end of the year, make sure it's there in your savings account before you sign that lease that increases your rent by $500 a month. Don't make the mistake of blowing it all in January and then overspending throughout the year in the hopes of a similar payout come the following December. You never know what might cause a bonus not to come through, and counting on money you don't yet have could mean setting yourself up for failure.
The article Are You Making This Major Budgeting Mistake? originally appeared on Fool.com.
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