Tax Refund and Bonus Time – What to do With that Stack of Cash?

What to Do With That Surge of Cash?

It’s that time of year again where a lot of people will be getting Tax Refunds and/or Bonuses from the prior year. When a lump sum comes in – you should be doing something smart with it. This post shares some simple spreadsheets that help cut through the noise from the numbers point of view and some reflections at the end.

If you are not getting a tax refund or bonus – please see my post on The Case for Over Withhold on Your Taxes.

The Case Against Doing Nothing and Sitting in Cash

First off lets get this argument out of the way: “I don’t know what I want to do yet so I am going to just sit in cash.” You likely have some sort of debt and we are currently in an age where you can earn at least 2%+ easily on your cash and this is inexcusable if you are reading this blog or any other financial articles out there.

Model Assumptions to Prove this out:

• 12 Month Outlook
• $10,000 of cash in hand (whether through bonus or emergency fund etc..)
• $30,000 of debt at 3.5% interest rate and interest only payments for simplicity
• No incremental cash flow – all debt payments and interest come from your existing cash for simplicity and isolating the dilemma

Results of Model – Beginning Net Debt Of Negative $20K goes down to Negative $21,050 of net worth all else equal:

The Case For Paying Down Debt:

Let’s refresh the model and just go after that pesky debt!

Model Assumptions to Prove this out:

• 12 Month Outlook

• $10,000 of cash in hand is applied 100% to debt (whether through bonus or emergency fund etc..)

• $30,000 of starting debt at 3.5% interest rate and interest only payments for simplicity

• No incremental cash flow – all debt payments and interest come from your existing cash for simplicity and isolating the dilemma

Results – Beginning Net Debt Of Negative $20K goes down to Negative $20,700 of net worth all else equal:

The Case For Investing:

Let’s invest that cash and give us options later if we need it. I refreshed the model with two scenarios below.

Model Assumptions to Prove this out:

• 12 Month Outlook

• $10,000 of cash in hand is 100% invested and earns 3% in one scenario and 4% in the other (whether through bonus or emergency fund etc..)

• $30,000 of starting debt at 3.5% interest rate and interest only payments for simplicity

• No incremental cash flow – all debt payments and interest come from your existing cash for simplicity and isolating the dilemma

Results – Beginning Net Debt Of Negative $20K goes down to Negative $20,760 of net worth if you invest at 3% and $20,662 if you invest at 4% all else equal and excluding taxes:

Mathematical Conclusion

Everyone’s debt terms and investment returns may result in other permutations to consider but what holds true is: Interest rates are interest rates whether it is debt or an investment. Mathematically the one with the higher after tax interest rate wins period.

All Those Qualitative Items

Ultimately there are other factors that should be considered:

1. Liquidity – Investments you can get in and out of pretty easily which can give investing the edge. See my post here on Actionable Passive Income – An Ease Simple Scalable Diversified and Liquid Income Portfolio Starting at $25
2. Stability of Return – paying off debt gives you confidence on the return you are getting which can provide it an edge. Investing yields are a best estimate heading in.
3. Your financing terms – everything from your interest rate, to payment, to your ability to take on debt after you pay down all have a factor. You will need to make a call on your individual circumstances if any of these terms are advantageous or not that may delay you from paying down your debt (or maybe accelerating payment).