Tuesday, March 13, 2012

Are you looking at your bonus properly?

This is the time of the year when a lot of companies are giving away annual bonuses. Festival and annual bonuses are things which people look forward to. The reason most of us do that is because bonus is like a 'windfall gain', where you receive a lot of money in hand in addition to your regular income. So bonus money is spent primarily on a lot of 'discretionary' purchases.

If you rationally look at your bonus, it is nothing but money you ought to have received with your salary every month. Would you have treated the money the same way had it been divided equally and given as part of your salary every month? Most of us would not have treated it the same. The reason for this is a phenomenon in behavioral finance called 'Mental Accounting'.Instead of looking at the big picture, people tend to mentally compartmentalize their assets into different "buckets," which they manage independently, and treat differently.As a result, it's easy to lose sight of the fact that each category of money (regardless of source) contributes to overall wealth.
It is due to this same reason that causes many taxpayers treat a tax return or refund as a "windfall" even though it's essentially their own money which they've overpaid to the Income Tax Department.

This article is not to pour cold water over all your plans to buy that latest gadget or take that vacation you always wanted, but to make you aware and more prudent with spending your annual or festival bonus. As stated in several posts, I only seek to maximise the wealth of my readers. And with that objective in mind, I have compiled the following points.

1. The day you receive your bonus, DO NOT buy anything. The highest chances of splurging happens the day you are most euphoric about your bonus

2. Do you have debt? Credit Card debt, personal loan, car loan, education loan or housing loan? You could use a part your windfall to reduce your debt especially since interest rates are so high now.

3. Do you have an investment plan? If you have not started investing yet, then this is a good opportunity to start an SIP in a mutual fund or put it in an FD or PPF or FMP.

I saw a program on TV where a person was saying that he divided his bonus in to 3 - One-third on something his family really wanted, one-third on replacing his bike and the remaining one third in repaying debt & in investments. This sounds like a balanced plan and probably you could consider using your bonus on these lines tailored to suit your needs.

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