December 2004  Email this  Print this
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CASH FLOW
Capitalize on New Capital
by Kimberly Lankford
Maybe this year you'll get as lucky as Janelle Watson. The 24-year-old naval officer in Norfolk, Va., is about to be promoted to lieutenant, junior grade, which will boost her monthly pay by $500. She wants to make sure the money goes toward building a better future rather than being squandered on instant gratification. That's the beauty of getting a year-end raise or bonus -- it's one of the rare opportunities to make a big difference in your finances without having to make sacrifices. You've been living without the money until now, so you can take any financial medicine you need without altering your lifestyle.
Financial triage
Extra cash should first be used to solidify your base, says F. Dennis De Stefano, a financial planner in Maui, Hawaii.
Pay off credit-card debt. This can have a gigantic ripple effect on the rest of your finances. As soon as you stop paying high interest charges each month, you'll have more money to devote to other goals.
Beef up your emergency fund, if you don't already have three to six months' worth of living expenses in a safe and liquid account. That way you won't have to go into debt or raid long-term savings for unexpected bills. Visit www.kiplinger.com/finances/yields to find the best money-market account.
Boost contributions to your 401(k), if you haven't hit the limit. You'll avoid paying taxes on the extra cash, and you may earn free money if you get an employer match. Or invest part of your bonus in your IRA if you haven't contributed $3,000 for 2004 ($3,500 if you're 50 or older). If you've already hit that limit, use your bonus to make your 2005 IRA contribution in January (the limit rises to $4,000 next year, $4,500 if you're 50 or older) or earmark a chunk of your raise each month.
Other good causes
After you've boosted your financial foundation, you have more flexibility. Watson is already in great shape -- she's maxing out her 401(k) and Roth IRA contributions -- but she still has about $17,000 in student loans hanging over her head. The loans carry a low, 3.5% rate, so she's trying to choose between adding the $500 a month to her loan payments or investing the extra money.
With an interest rate that low, paying off the loan doesn't need to be a priority. "If you can earn at least 3.5% in the marketplace, and I believe that you can, then investing is the better way to go," says Brian Jones, a certified financial planner in Fairfax, Va. Investing becomes even more important if you need to save for a short-term goal, such as buying a house.
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