Four Ways to Maximize Your First Financial Windfall
December 13, 2023
- Private Banking
Relationship Associate Elise Johnston provides strategies for making the most of your income and getting on the path toward achieving long-term financial growth, stability, and success.
- Budgeting
- Saving
- Investing
- Giving
For many recent graduates, entering the “real world” comes with many firsts: first apartments, first full-time jobs, and in some cases, first financial windfalls (e.g., a sign-on or performance bonus or the first distribution of a trust).
It can be easy to feel overwhelmed by the financial freedom that comes with receiving a large sum of liquid cash for the first time. Financial smarts are more important than ever during this transition period.
While spending your first bonus on nice restaurants or luxury items might sound like an ideal way to celebrate the start of adulthood, it isn’t the best way to build a solid financial foundation for the years to come. Having your own, well-earned money for the first time can be overwhelming, but there are ways you can still spend while saving enough to set up your future self for success.
The following four strategies for managing your first financial windfall – budgeting, saving for retirement, investing to promote financial growth, and charitable giving – will allow you to maximize your opportunities and get you on the right track to achieving long-term financial goals.
Budgeting
No matter what your financial standing is, budgeting is key to ensuring you are set up for success.
While it might be tempting to purchase your fifth latte of the week or splurge on those concert tickets you’ve been eyeing, spending on impulsive whims will not set you up for long-term financial growth. Setting parameters for yourself teaches the invaluable skill of self-discipline, which means you’ll still be able to spend money on “unnecessary” things like coffee and concerts but in smaller, more infrequent doses.
When setting a budget for yourself, it can be useful to stick to the 50-30-20 rule. This rule suggests designating your after-tax dollars into three main categories: needs, wants, and savings. The goal is to limit necessary expenses – including housing, transportation, food, utilities, and healthcare – to 50% of your spending while allocating 30% to discretionary expenses (“wants”) and 20% to savings.
If you need a more structured budget or simply want an easy place to track your spending and saving progress, there is a wealth of budgeting apps that deliver a complete financial picture that you can use to inform your budget. You can stay on top of your bills and subscriptions by bringing all of your accounts onto one platform. You can also set spending limits for yourself in different categories, such as food delivery and entertainment services, and create a savings goal for the year. Many apps will notify you when you’ve gone over the monthly budget you set for yourself, providing a friendly reminder to tone spending down when necessary.
By being aware of your spending habits, you can better set limits for yourself that fit your financial needs. Take some time to assess your spending – and overspending – and evaluate how much you want to save. Try to stick to it, because that extra cash can be worth way more if you save it!
Saving for Retirement
You may wonder, “What is the point of locking away all this money in a retirement account at the time in my life when I arguably need it the most?”
Most employers match some percentage of an employee’s contributions to a 401(k). While you might not make enough to max out your retirement account each year, you should strongly consider maximizing the perks of a retirement account by putting in as much as your employer is willing to match.
First, your contribution is not literally locked away until you retire. Though the money is there should you need it, it’s important to note that an early withdrawal from a 401(k) or a Roth IRA can result in steep penalties and fees. Try not to withdraw money early unless you absolutely need to.1
Second, time is of the essence when it comes to saving for retirement. With compound interest, someone making even an average income is still able to build a sizable retirement portfolio.
What will your retirement savings at age 70 look like if you start contributing to your IRA at 25 years old? Let’s assume the following: you max out the contribution limit every year ($6,500 in 2023 and $7,000 in 2024), the contribution limit doesn’t change, and there is a 6% after-inflation return on investment. Under these conditions, by the time you are 70, your IRA balance will be $1.47 million.
A 401(k) has a higher annual contribution limit – up to $22,500 in 2023and $23,000 in 2024 – so assuming the same conditions, after 45 years your balance would grow to more than $3.5 million. Coupled with employer matches, this balance would be even larger.
Even if you can’t max out either account, time – and compounding – is on your side. Strive to save as much as you can for retirement, starting as early as you can.2
What does it mean to max out your account? The IRS sets limits for how much money you can put into your retirement account each year. The current limit for a 401(k) is $22,500, while the IRA limit is $6,500 (in 2024, these limits will be $23,000 and $7,000, respectively). Whether you max out your account or only put a small percentage of your paycheck toward retirement, both will allow you to turn an average income into a solid retirement portfolio.
Put money into a savings account.
Now that you’ve set a budget for yourself and put money aside for the golden years, it is time to use that extra cash and put it into a savings account. The very act of putting cash into savings can reduce the likelihood that you will spend it. So, before you dive into the miraculous world of investing, simply start by distinguishing your spending funds from your savings. The sooner you start saving, the better.
Investing to Promote Financial Growth
As the saying goes, the most important investment decision you can make is to invest. No matter what you choose to invest in, investing in your 20s can have an immense impact on your financial standing decades down the road. As for how much to invest and where, there is no one way to do it. Take the time to do your due diligence and make investment decisions that suit your interests and financial goals.
I sat down with my colleagues Sid Arora and Miles Petrie, members of our 1818 Partners team (BBH’s concentrated small and midcap team), to hear about what they wished they had invested more heavily in at the start of their careers.
Sid: “I’d invest in low-cost S&P 500 index funds and ETFs. This is the low-cost way to compound capital over a long period of time at relatively attractive rates of return.”
To the extent that a 20-something was to dabble in stocks, Sid suggests picking the highest-quality blue-chip businesses whose products you use and touch daily (i.e., businesses you can easily understand) as a good place to start your diligence.
Miles: “While equities are more volatile than fixed income, if you are investing for the long term, you have the ability to ride out short-term volatility to, in principle, benefit from potentially higher levels of return on taking that risk.”
The most straightforward way of investing in equities is via index funds, such as ones that track the S&P 500.
“If you invested $10,000 in the S&P 500 20 years ago and let it sit in your account, it would be worth $70,000 today,” Miles added.1
Picking individual stocks requires a lot of time and research as well as expertise in investing concepts such as valuation. On top of that, frequently buying and selling securities has tax and transaction costs that the typical retail investor underestimates. Even as a professional stock picker, Miles invested most of his personal money in index funds with a long-term view out of college. “That’s not to say passive indexes and ETFs are the only way to outsource your investment in equities,” Miles said. “There are a lot of excellent active managers out there, but selecting those also requires careful research.”
The consensus from our investment pros seems to be: keep it simple, invest aggressively (as much as you can), and think long-term!
Charitable Giving
December, which is officiallygiving season, is a good time to start thinking about where you would like to make a donation.
In the eyes of many, having the power to improve the lives of others is a privilege, and with that comes a sense of responsibility. Acting on these feelings of responsibility is a great way to instill personal values and make a difference in someone else’s life, no matter how small that difference may be.
Not only does donating to charity have a vast impact on the individuals or organizations you are donating to, but studies show that there is a strong positive correlation between giving and level of happiness.
If happiness does not have you convinced, it is worth noting that donations you make to qualified charities are tax deductible and can reduce your taxable income, which in turn can lower your tax bill.
Conclusion
Coming into your first unexpected financial windfall as a young adult – whether it’s a bonus from your employer or the first distribution of a trust – can be exciting and intimidating at the same time. You are now responsible for managing, and ideally maximizing, a large sum of cash – all while tackling the plethora of responsibilities of adulthood.
These four strategies can help you navigate the balance between spending enough to enjoy your post-graduate years while saving enough to build a strong financial foundation.
Over the years, you will learn to find a balance between saving money and having some to spend for fun that works for you, your lifestyle, and your goals. Reach out to the BBH Next Generation team if you are interested in further building upon your financial goals.
Lindsay Hodgkins
Assistant Vice President
Multi-Family Office
Next Generation Experience
Private Banking
New York City, NY | USA
Email Call
Mackenzie Dowling
Assistant Vice President, Relationship Manager
Multi-Family Office
Next Generation Experience
Private Banking
New York City, NY | USA
Email Call
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1 Withdrawals of taxable amounts are subject to ordinary income tax to the extent of gain and a 10% federal income tax penalty may apply prior to age 59 1/2.
2 This hypothetical example is for illustrative purposes only.
3 Past performance does not guarantee future results.
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