Smart ways to use festival bonus

As the festive season draws near, many employees eagerly look forward to receiving bonuses for festive spending. However, a portion of the bonus can be used to improve long term financial health. Strategic allocation can help reduce debt, create financial safety nets and help achieve long-term financial goals sooner. Here are some prudent ways to deploy festive bonus:

Create emergency fund

Salaried individuals must create an emergency fund for non-discretionary spends like utility bills and children’s education for at least six months. During economic or job-related uncertainties, the size of this fund should be increased to cover expenses for at least 12 months. Without the fund, you may be forced avail loans at high interest rates or liquidate investments earmarked for important financial goals. So, consider using surplus festive bonus to create or top up emergency funds.

Prepay loans

If you are servicing a loan with a long residual tenure, using bonus to prepay the loan can be a smart move as it will cut interest cost. While making prepayment, choose the tenure-reduction option as it will save more in the long run. However, the EMI will stay the same. Opt for EMI reduction option only if you want to raise disposable income.

Buy life/health covers

Life insurance is designed to give financial security to dependents in the event of untimely demise. Ideally, the death benefit must be at least 15 times of annual income. The most cost effective way to secure such high coverage is to buy term cover. Thus, employees with insufficient/no life cover can mull using festive bonus, or a portion of it, to buy term plans. Also, they should have adequate health and personal accident plans to guard themselves against the financial risk from hospitalisation or accidents.

Invest in corporate bonds/FDS

For short-term financial goals, investors should prefer fixed income instruments like FDs and bonds.

As the repo rate cut of 100 bps this calendar year led to a huge drop in bank FD rates, more cuts may push FD rates down further. Thus, for stable and assured returns, consider using bonus to invest in high-yield FDs. The highest FD slab rates offered by some small finance banks (SFBs) are still 100–150 bps higher than those offered by most PSU and large private sector banks. Also, SFBs have been categorised as scheduled banks by the RBI and deposits with SFBs are insured under the deposit insurance programme of DICGC, an RBI subsidiary. This covers deposits (savings, FD, recurring and current accounts) of up to ₹5 lakh held by each depositor with each scheduled bank. For those with slightly higher risk appetite, investing in corporate bonds can be a good alternative to earn higher fixed interest income. These bonds usually offer higher returns than bank FDs, small savings schemes or government bonds. Interest payouts (coupon payments) may be monthly, quarterly or half-yearly, depending on the bond. Coupon rates (interest rates) largely depend on credit ratings. To minimise market risk, choose bonds with maturity dates aligning closely with that of financial goals.

Invest in equity mutual funds

Equities have usually outperformed inflation and fixed-income instruments by a wide margin over the long term. This makes equities the most effective asset class for wealth creation over long term. If you already have an adequate corpus set aside for short-term needs, consider investing surplus bonus in equities, preferably in equity mutual funds for long-term financial goals. Use systematic investment plans as it will ensure rupee-cost averaging during market corrections and thereby, save you from the hassle of market timing.

(The writer is CEO of Paisabazaar)