A tax refund, an end-of-year bonus at your job, a birthday gift from a loving grandfather/grandmother, or simply a few months of budgeting can be enough to give you one thing in common with many other families; some additional funds. The issue then is how to use them.

Some families would like to repair their leaky faucet (a long standing problem) and take that dream vacation. While others believe they should stash every last penny in a savings account for the future. There is no correct decision about spending or investing extra money as a family when considering if to spend or save your extra cash. However, there is a logical process to go through.

Start With the Safety Net

The first step is to identify whether your household has enough of a safety net to cover emergencies. Most households aim to hold at least several months of their basic monthly expenses in an easily accessible savings account. This money is not intended to generate significant earnings. Rather, its role is to ensure that a serious setback (like a major auto repair) doesn’t become a disaster.

If you don’t currently have sufficient funds to weather a series of setbacks, using excess funds to build up your reserve is likely the best course of action. Building up your emergency fund is not glamorous, but it provides tangible peace of mind.

Pay Down Expensive Debt

Once your emergency fund is adequate, the next priority is typically to address high-interest debt. High-interest credit card balances and certain personal loans carry interest rates high enough that reducing those balances can be viewed as generating a near-guaranteed return on invested funds.

In addition to providing a nearly guaranteed return, eliminating high-interest debt reduces the amount of money that is being required to service debt each month. For example, if you owe $5,000 at 20 percent annual interest, you’re paying $1,000 per year just to keep the debt outstanding. Once you’ve paid off that debt, you’ll have an additional $1000 available for saving, investing or enjoying in subsequent months.

To address multiple debts with varying interest rates efficiently, consider the following strategy:

  • list out all of your debts by balance and interest rate
  • pay the minimum due on all debts
  • direct any additional funds toward the debt with the highest interest rate
  • when the debt with the highest interest rate is eliminated, apply its former payment to the next-highest-interest-rate debt
  • continue applying the payments from previous debts until you’ve cleared all of your high-interest debt

Debt with lower interest rates—such as mortgages—is treated differently. While some families choose to continue making regular mortgage payments and build savings and investments simultaneously, others simply continue making the regular mortgage payment without changing their spending habits.

When Spending on Your Home Makes Sense

There are instances in which spending money improves your quality of life today and saves you money in the future. Two examples of this include repairing items around the home and upgrading outdoor spaces. Repairing a leaky roof or installing new insulation in your attic may prevent costly damage and lower your energy bills.

Outdoor areas are another area where you might find it worthwhile to upgrade based upon your family’s needs and lifestyle. For example, replacing a weathered wooden deck with a low-maintenance composite deck will allow you to eliminate the necessity of annually sanding and sealing the wood to extend its lifespan.

Additionally, since composite decking produces less splintering hazard to younger children playing on it; you’ll also free up additional time for family activities during weekends that were previously spent maintaining the deck.

Before committing large sums of money to any projects, take these steps:

  • Ask yourself if this item will provide us with enjoyment on a weekly basis, or only occasionally.
  • Will this purchase help save me money on future repairs or operating costs?
  • Can I afford this without tapping my emergency fund?
  • Would this make our property more attractive if we decide to sell in the future?

Getting Started With Investing

After you’ve addressed both your safety net and any expensive debt, investing can help grow your wealth over time. The primary advantage that a family has when it comes to investing is time. Returns on investments can compound significantly when given ample time.

To help determine what portion of your money belongs in each type of investment, think about how long you expect to wait until you’ll need each segment of money. Money needed within two years (for example, money to buy a new vehicle or save for a down payment on a new home) will generally belong in safer investments.

Conversely, money intended for goals 10 years or further in the future (for example, retirement savings) can generally withstand larger market fluctuations.

Be cautious with anything sold as a high return investment. Generally speaking, any investment promising higher-than-average returns carries greater risks than average. Therefore, carefully review any promotional literature related to proposed investments. Understand how and when you’ll be able to withdraw monies invested, and be confident you could absorb any decline in investment values.

Diversifying your investments among various asset classes can reduce your exposure to losses in the event one particular class performs poorly. If you’re uncertain regarding the initial investment steps for your family, a registered investment advisor may assist you in creating a customized plan designed to meet your specific objectives.

Talk It Through as a Household

Money-related decisions flow better when everyone contributing financially takes part in the discussion. One spouse may view surplus funds as a source of relaxation after working hard for extended periods of time. Another may view it as a hedge against uncertainty.

Set aside 30 minutes of uninterrupted time together to discuss what matters most to each individual at this point. Compare lists and try to identify commonalities in your priorities.

Having a shared plan prior to receiving extra funds makes it considerably easier to adhere to it. Furthermore, establishing a shared plan eliminates the frustration experienced by one member of the partnership spending what they believed was reserved for savings purposes.

Saving for Your Kids’ Future

A great deal of parents desire to set aside some money for their children, regardless of whether it is for their educational pursuits, first vehicle or early adulthood. Although small, consistent contributions made regularly over time can lead to substantial accumulations of capital.

Automatically transferring money from your paycheck to a designated savings account (or to a savings account owned jointly by spouses) facilitates consistency in adding funds over time. You can also request relatives (i.e., grandparents) contribute to a savings objective instead of purchasing gifts at birthdays.

Involving mature children in this process offers them opportunities to develop important skills. Illustrate how the account balance increases over time, explain why you save, and give them responsibility for minor financial choices with their own funds.

Watch Out for Lifestyle Creep

As income increases, so too frequently does spending without anyone even realizing it. Buying an upgraded vehicle that isn’t necessarily necessary, ordering additional delivery meals (which tend to be costlier than cooking at home), and signing up for a few additional subscription services can gradually consume any wage gains.

One method for avoiding lifestyle creep involves deciding immediately how much of the increased income will be dedicated to building up your reserves. By automatically allocating that sum toward savings, you won’t miss spending it.

Leave Room for Joy

Creating lasting ties within your family unit and developing memories that persist beyond the expenditure itself can result from utilizing some of your surplus funds for leisure-based experiences.

Some families allocate most of any windfalls toward savings and debt repayment while reserving a smaller share for discretionary uses. Thus, every member of the household benefits from having the funds available now as well as in the future.

Your “fun money” does not require extravagant expenditures. A long-awaited camping excursion with the entire family, a family membership pass to an amusement park/attraction in your region or obtaining a bicycle for a young child can feel very rewarding without jeopardizing your larger objectives.

Finding the Right Balance

Ultimately determining whether to utilize spare cash for spending or investing depends upon your household’s preferences. Construct a reserve sufficient to safeguard against unforeseen events. Clear any excessive debt. Spend prudently on items that enhance your quality of life. Invest for goals that are most relevant.

There is no universal solution. Each household’s needs evolve as their children grow. What is critical is that you deliberately and as a household make each decision regarding your finances.